On September 7, 2008, Bush Treasury Secretary seized Fannie Mae and Freddie Mac (the GSEs). At the time, the GSEs backed $5.4 trillion in mortgage loans, or one half of the total residential mortgage market. Up until that date, the GSEs benefited from an implicit guarantee. After government seizure, the guarantee became explicit.Yesterday, in its report downgrading the US, S&P cited their earlier report projecting total losses to the government approaching $700 billion from the assumption of the GSE's liabilities. Others suggest a worst case scenario of $1 trillion. As of August 2010, total losses reached $226 billion and the government had injected $148 billion in capital. Since then losses continue to mount with the announcement yesterday that Fannie increased its loss reserves for mortgage losses to $75 billion. So by any measure, the bailout of the GSEs constituted an enormous expense incurred by the last administration that greatly contributed to our debt problem and the S&P downgrade yesterday.
The Fannie and Freddie bailouts have been termed "the mother of all bailouts." This seems apt due to both the huge amount of money at stake in the ultimate unwinding of the GSEs as well as the centrality of Fannie and Freddie to the US financial system. Mortgage backed securities issued by the GSEs constitute 29% of the taxable bond market in the US, nearly as much as Treasuries. Currently, the spread between Treasuries and GSE securities are near record lows as illustrated by this graph:
This graph shows that the market currently believes that GSE paper is about as safe as Treasury obligations. It also shows that the bailout was an unadulterated giveaway to holders of GSE obligations. More specifically, to the extent the spreads have compressed over time due to the more explicit government guarantees, holders achieve a windfall in the form of higher bond prices for their holdings arising from the more explicit guarantee. None of this windfall went to debtors on the underlying mortgage backed securities (MBS), as they continued to be obligated at stated interest rates on notes entered into prior to the more explicit guarantee. In other words, 100 percent of the government's expenditures to make good on the MBS guaranteed by the GSEs went to wealthy holders of the MBS (bond investors, banks, and foreign governments like China) on September 7, 2008, and none of it benefited the home owners obligated on those debt obligations. Thus, we bailed out bondholders and banks and rich investors, not homeowners on September 7, 2008.
After the bailout homeowners benefited from lower mortgage rates, but this benefit may not last much longer. The Housing and Economic Recovery Act of 2008 granted the Treasury the authority to provide the GSEs with unlimited capital (by purchasing their stock) in order to maintain their solvency, and Treasury exercised this power to cover losses through 2012 (plus $200 billion each). After that, unless Congress acts, the GSEs are on their own. Their fate will be in the hands of this current Congress--the very Congress that just triggered an S&P downgrade based on "political brinkmanship." As managing director of S&P John Chambers stated: "The political gridlock in Washington leads us to conclude that policymakers don't have the ability to put the public finances of the U.S. on a sustainable footing." The GOP arson squad lacks sufficient political maturity to deal with the GSEs in a responsible way.
Therefore, it would be hard to imagine that the GSEs would maintain their credit ratings much longer. And, unlike Treasury debt, the market for GSE paper could see a disorderly unwinding as investors who currently believe they hold bonds nearly as safe as Treasuries are in fact subject to the whims of the current Congress. That could spell trouble for the financial markets, bank capital, the residential real estate market and the economy generally.
"Yesterday, in its report downgrading the US, S&P cited their earlier report projecting total losses to the government approaching $700 billion from the assumption of the GSE's liabilities. Others suggest a worst case scenario of $1 trillion ... The Fannie and Freddie bailouts have been termed "the mother of all bailouts."
ReplyDeleteWhat? A TRILLION dollars! "The mother of all bailouts"? How can this be? You assured us over and over again that the GSEs were "bit" players in the mortgage crisis. Maybe you've finally had a chance to read "Reckless Endangerment" written by two right-wingers, Gretchen Morgenson and Joshua Rosner, who just happen to work for that bastion of conservatism - The New York Times. Of course, I jest, conservatives are blacklisted at the Times. Just like they're effectively blacklisted from the faculty of almost every major university in the country.
Morgenson and Rosner lay waste to your "bit player" arguments, and they pull the manhole cover off the sewer of Democrat corruption at the GSEs. When even NYT reporters are unwilling to ignore the lies being told to cover up the Democrats key role in our current financial crisis you know that a day of political reckoning is near.
" ... the bailout of the GSEs constituted an enormous expense incurred by the last administration that greatly contributed to our debt problem and the S&P downgrade yesterday."
Yes, it was an enormous expense, incurred only because of the corruption and intransigence of the Democrat Party. Bush tried several times to reform the GSEs and increase regulatory oversight of their reckless lending practices only to be stopped at every turn by the Democrats in the Congress. So, while the expense may have been incurred during "the last administration" the blame falls squarely on the Democrats.
"... the bailout was an unadulterated giveaway to holders of GSE obligations ... holders achieve a windfall in the form of higher bond prices for their holdings arising from the more explicit guarantee. None of this windfall went to debtors on the underlying mortgage backed securities ..."
ReplyDeleteWhat color is the sky in your world? Of course the holders of GSE obligations benefited from the implicit and explicit guarantee of GSE debt. They loaned their money to the GSEs in good faith, accepting a lower interest rate because of these guarantees.
As for the debtors - many of whom made little or no down payment and lied about their incomes, jobs, etc. - they got a lower interest rate on a loan that they otherwise would not have qualified for. Funny, you never heard any whining by the left when the houses that were purchased under such fraudulent terms were appreciating in value and it all looked like "money-for-nothing". No, it was only when the market turned and the one way bet ended that the left, in need of a scapegoat, invented the concept of "predatory lending".
" Their fate will be in the hands of this current Congress--the very Congress that just triggered an S&P downgrade based on "political brinkmanship."
Is their any depth to which you will not stoop in your effort to shield the Democrats from consequences of their incredible recklessness? Here's an excerpt from a NYT article written before the November 2010 elections, when the Democrats had absolute power in Washington D.C. and could have addressed the downgrade threat in any manner that they chose:
"Moody’s, Standard and Poor’s, and Fitch — warned that they might have to downgrade the triple-A debt of the United States if it failed to bring its budget deficit under control ... the agencies seem to be following Wall Street’s new favorite meme that “runaway government spending” in response to the crisis represents a mortal threat to the American economy."
The New York Times, March 20, 2010
Why didn't they act then? No, the downgrade was triggered by the Democrats reckless spending binge over the last two and a half years during which they run trillion dollar plus deficits and have increased the national debt by more than a third. S&P simply concluded that based on the Democrats lack of seriousness in addressing the fiscal mess, and the Republicans lack of power to address it, that the deficits and resulting debt increases would most likely not be address in any real and effective manner.
In response to your claim that Freddie and Fannie were the sole cause of the crisis:
ReplyDeletehttp://www.nybooks.com/blogs/nyrblog/2011/jul/13/why-fannie-and-freddie-are-not-blame-crisis/
http://www.cepr.net/index.php/blogs/beat-the-press/george-will-spreads-some-lies-about-the-economic-crisis
http://real-estate-and-urban.blogspot.com/2011/07/mark-thoma-and-dean-baker-are-correct.html
http://moneywatch.bnet.com/economic-news/blog/maximum-utility/fannie-freddie-and-the-cra-did-not-cause-the-financial-crisis/1513/
I have never asserted that the GSEs hold zero blame. My more moderate position is that they were a bit player, smaller than flawed corporate governance, TBTF, the repeal of Glass-Steagall, the non-regulation of derivatives, flawed globalization, continued racial oppression in America, the war on the middle class, the Bush Tax Cuts, the non-regulation by the Fed of subprime loans, deregulation of capital standards, the PSLRA, the SLUSA, destruction of the regulatory agencies, mindless deregulation, and the excessive use of monetary policy in lieu of any real economic policy.
It was also purely bi-partisan, as the list above suggests.
By the way, the GOP FCIC members abandoned Wallison on his Captain Ahab quest to pin the whole thing on the GSEs.