Fannie, Freddie and Mortgage Addiction

August 25, 2010

By Chidem Kurdas

In the first inning of what looks to be an intricate political game, the Obama administration and its financial industry allies suggested that the economy needs the federal government full force in the mortgage market.

The case was pithily made  by bond honcho Bill Gross,  who oversees more than $1 trillion of investments as head of giant bond shop PIMCO and was a speaker at the Treasury Department’s conference on the future of Fannie Mae and Freddie Mac.

“Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending,” he wrote in a recap of his talk.

It’s an argument  that is at once practical and yet nightmarish. Heroin dealer has his customers hooked. They can’t do without him. Therefore they will have to make sure he stays in business and continues ministering to their needs.

Government-created and -backed mortgage monsters own almost $5 trillion of debt.  Mr. Gross asks: “how could private market advocates reasonably assume that pension, insurance, bank, and PIMCO-type monies would willingly add nearly $5 trillion of non-guaranteed, in many cases junk-rated mortgages to their portfolio?” Since they would not, “We are in a bind, folks.”

As a necessary solution, he proposes to fold Fannie, Freddie and other housing agencies into one giant federal office that will guarantee a majority of current and future mortgages. The idea is to move the $5 trillion to the federal budget and get taxpayers to fully support mortgage lending.

Privately originating and securitizing mortgages will carry a high cost, Mr. Gross says—private lenders will charge high interest rates and at those rates few people can afford homes.

We’re assured that taxpayers will be protected. Tight regulation will transform the heroin dealer into an upright, conscientious bureaucrat. Funny. Taxpayers are expected to guarantee loans at cheap rates and take high risks that no private lender will countenance. Yet somehow taxpayers are going to be alright. Regulation will suddenly become effective. Yet it failed for decades.

Encouraged by politicians – notably Barney Frank the financial reform showman – Fannie and Freddie pumped air into the real estate bubble. The collapse of the bubble caused the recession. The government spends our money to fuel the boom-bust cycle, then spends our money to reduce the pain of the bust. It’s the heroin dealer offering his hard-up customers credit to tide them over.

The only real solution is to say no to the addiction. You have to start modestly and slowly, but at least in the right direction.

Yes, the private market can’t absorb the gigantic $5 trillion debt. Not at once. The key is to sell the accumulated mortgages slowly, in small increments. This will take years— after all, it took decades for the government to create the mess. The objection that shutting down Fannie and Freddie will worsen the current property slump does not make sense. Setting up the process will take a long time. The real estate cycle will turn by then.

Mr. Gross is arguing his trade book, his protests to the contrary notwithstanding. PIMCO is a huge buyer of agency securities. Yes, privately issued securities have higher yields, but they’re not as plentiful. Having lots of paper available is advantageous for a buyer. He’s no doubt right that the market would be smaller if the government starts to withdraw. Without a subsidy, some people will not buy.

They’ll rent instead. That way, they won’t risk defaulting on mortgage payments. No easy doped-up credit to feed housing booms means less chance of busts. Is that a problem? It is to the federal subsidy pushers.

14 Responses to “Fannie, Freddie and Mortgage Addiction”

  1. Richard Schulman Says:

    Nice post, and timely.

    But isn’t it possible that “gigantic $5 trillion debt” is a scare number? What would that paper sum amount to if marked to market? Does the “cold turkey” of the mortgage GSEs really have to perpetuate itself until my yet-to-be born grandchildren retire?

  2. chidemkurdas Says:

    Good question, Richard Schulman. That is something that needs to be looked at. I have not seen an independent analysis of mark-to-market values. Fannie is very secretive and outside analysts would have a hard time obtaining detailed information about the portfolio.


  3. Excellent post.

    Gross is clearly talking his book. I assume the Chinese have expressed their concerns in private.

  4. chidemkurdas Says:

    It would be fascinating to be a fly on the wall when the Chinese express their concerns. I had not thought about that angle but of course they are the big player.

  5. Troy Camplin Says:

    Government interference and regulations have failed us miserably, so what we need is . . . for the government to take over what it’s ruined! Brilliant. I call it the “Michael Moore Solution.”

  6. krf Says:

    used to work at FRE. They did not realistically mark their retain portfolio to market. They are secretive. They hate FNM and Barney Frank. Mid-level officers that were there during the nonsense that led to the mistatement are STILL there and they are corrupted by greed. Whatever gets them the biggest bonus is what they do. Don’t ever think that they meant to HELP increase home ownership out of the goodness of their heart of the CRA. It was all about making as much $ as possible.

  7. chidemkurdas Says:

    krf, that’s fascinating. I have to say I know less about Freddie than Fannie. But what you say confirms that basic premise of public choice economics: people are the same whatever the supposed public purpose of their activity. That individual bureaucrats work to maximize their bonuses is not surprising.

  8. chidemkurdas Says:

    Yes, Troy, they do it, it fails, they do even more of the same, fails again, and so on. You could also call it the Vicious Cycle Game.

  9. Greg Ransom Says:

    2 years ago Bill Gross was pushing a plan to destroy 1/10 of the U.S. housing stock in order to prop up the housing mortgage market.

    In other words, Gross would put millions of Americans out on the street if need be to make himself a bit more wealthy.

    And the guy wasn’t kidding.

  10. Troy Camplin Says:

    Broken windows. Again.

  11. chidemkurdas Says:

    It makes sense that Gross wants the subsidies and guarantees to continue or even grow. After all, he’s holding the bonds backed by subsidized housing & guaranteed by the federal government.


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