The Fate of Fannie and Freddie

Fannie Mae and Freddie Mac opened trading at record lows due to rumors about a possible bail out.  I’m writing this waiting to hear an announcement from Treasury Secretary Paulsen….

If you are in a transaction at this time and your mortgage fits within the FHA loan limits ($567,500 for King, Pierce and Snohomish County), I recommend considering FHA as a back up plan.  In fact, I’ve realized yesterday that all of my loans in process are currently FHA.   ,

If you are considering buying or refinancing a home and are not yet in transaction, I highly recommend making sure that your Loan Originator is able to provide FHA financing.   I recommend asking your Loan Officer (in writing-using email):

  • Are they approved to provide FHA financing?
  • How long has their company provided FHA financing?
  • How long has the LO done FHA loans?
  • Verify on HUD’s website that the mortgage company is indeed approved with HUD.  This list will also show you how long a company has been approved by HUD.

What will the Fannie and Freddie look like after if the Gov steps in?

If you look at FHA, you know that HUD is very pro-homeownership.   We may see low down programs like Flex 97 stick around–it’s very similar to FHA with the minimum 3% down.

Mortgage rates will probably increase dramatically since we will no longer have a private sector.  It will all be government controlled.

I’m also wondering if the governement would utilize private mortgage insurance companies or if they will utilize something similar FHA’s mortgage insurance?

Stay tuned…this is not over.

Update 7:53 am:  Here is Treasury Secretary Paulsen’s statement (from Market Watch):

Here is Paulsen’s statement (from Market Watch):

“Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission.

“We appreciate Congress’ important efforts to complete legislation that will help promote confidence in these companies. We are maintaining a dialogue with regulators and with the companies. OFHEO will continue to work with the companies as they take the steps necessary to allow them to continue to perform their important public mission.”

Update 2:51 p.m.  I just received this Press Release from OFHEO (Office of Federal Housing Enterprise Oversight):

Statement of OFHEO Director James B. Lockhart

“I congratulate and thank Chairman Dodd, Ranking Member Shelby and the Senate for passing a sound and comprehensive GSE regulatory reform bill.  This bill should help restore confidence in the housing markets by creating, on passage, a new, stronger regulator with all the necessary tools to oversee Fannie Mae, Freddie Mac and the Federal Home Loan Banks.  I am hopeful the House will act quickly and the bill will soon be enacted into law.

With this very turbulent market it is important to strengthen the regulator of Fannie Mae and Freddie Mac and combine it with the regulator of the Federal Home Loan Banks as soon as possible as all of the GSEs are being asked to do more and more to support the mortgage market.”

136 thoughts on “The Fate of Fannie and Freddie

  1. I’m looking for “copy” of Paulsen’s statement. CNBC reports that Paulsen is stating there is no bailout on the horizon and the government will continue to support the GSE’s.

  2. This sounds like much to do about nothing. Doesn’t the government have to bail them out? Assuming they don’t have to, does anyone think they won’t?

    Planning for a possibility doesn’t make it imminent. The U.S. had plans to nuke the U.S.S.R. Somehow I don’t remember that happening.

  3. Yikes.

    Much ado about nothing? 5 trillion in loans with little cash reserves, with former fed president Poole calling them currently insolvent?

    Your idea of nothing is very different than my idea of nothing, Kary.

  4. Kary, I’m w/biliruben regarding your comment #4.

    If/when the Government takes over Fannie/Freddie–rates are going to go up dramatically. How will that impact the current real estate market?

    This is very signficant.

  5. I’m talking about the fact that they’re planning–that’s much to do about nothing. Not the underlying potential problem.

    I know government is inefficient and that it makes a lot of bone-headed decisions, but imagine how much worse it would be if they didn’t plan! 😀

  6. Have you looked at their stock price action the last few days? I would equate that with chunks of the Viaduct landing on tourists. Would the projects be imminent then?

  7. Good dialogue! Have you seen the NY Times article today on this topic? Very well written (balanced and detailed) about the issues at hand. Here’s a link FYI…
    This is VERY serious stuff and should this downward trend continue, you can bet your bottom dollar it’ll have a big impact on the real estate market. Rhonda, thanks for your commentary and updates. Great job!

  8. I’ll have rates posted around lunch time at RCG. The markets are very volatile today and I’m all ready receiving rate changes for the worse from what I posted this morning @ Mortgage Porter.

  9. The stock price is only relevant to their raising new capital, and then only if they do it through a stock offering.

    A couple of years ago there was talk of a Ford bankruptcy. That talk didn’t change any of the underlying facts about the company. It did present a good buying opportunity, however.

    There was news just a few days ago about the financial situation these two companies are in. This article today doesn’t change any of that. The underlying story is still the same.

    Stated differently, this is not new news. I only shrug it off because it’s not new. We knew about this earlier. And also because this news does not make anything happening within the next 60 days any more likely than before the story came out.

  10. bili wrote: “Have you looked at their stock price action the last few days? I would equate that with chunks of the Viaduct landing on tourists. Would the projects be imminent then?”

    Bili, I suspect you know how the stock market works, and how the price of a companies stock means not that much to the company itself at most times. If it’s low it’s a bad time to make an additional offering, and if it’s high it’s a bad time to buy it back.

    The people directly affected by the stock price are the owners of the company, not the company itself.

    So no, I would not equate what happened to the stock price today to be anything like the viaduct starting to crumble.

    BTW, no one has answered my question. Does the government have to bail out these entities? I’m not sure of the answer to that.

  11. Kary, I disagree. If a borrower has anything in the works conforming over the next 60 days, it wouldn’t hurt to make sure they’re working with a LO who can quickly switch to an FHA product IF needed.

    Everyone needs a “plan b mortgage” right now.

    In this climate, we are receiving very little notice when changes happen. You just commented on my IndyMac post how surprised you are that IndyMac is now gone.

    Any changes may be swift.

  12. I found this on MSNBC: “Congress created the companies to provide a steady stream of money for home mortgages. Although the government doesn’t guarantee Fannie’s and Freddie’s debts, most investors believe the government would come to their rescue if the companies fell into dire straits. This “implicit

  13. “The stock price is only relevant to their raising new capital, and then only if they do it through a stock offering.”

    And they need new capital.

    You’re right when you say their fundamentals haven’t changed. However the markets are finally figuring out how bad their situation is.

  14. Kary, re: 18, any borrower with less than 20% down, I’ve had a back up plan for…I recently had a closing where originally the borrower was approved for Flex 100 and they wound up buying using Flex 97…they were also prepared to buy FHA if Flex 97 went away.

    Where my advice is different than before is that I now recommend, even if a borrower is putting down 20%, if their loan amount is up to (or near) $567,500, they should consider having an FHA back up plan.

  15. Shane wrote: “You’re right when you say their fundamentals haven’t changed. However the markets are finally figuring out how bad their situation is.”

    Or the markets are overreacting in the same manner they did a few years ago when bankruptcy rumors were spreading regarding Ford.

    But let’s put it this way. I bought Ford stock back then. I’m not going to buy stock of either of these entities today or this week.

    Rhonda, I can see that change of advice for 20% down people. But hasn’t the advice for about 6 months or so been to have a broker that can do FHA?

  16. There’s no easy way out here. If the government decides to let the GSEs fail, rates will go up as risk premiums adjust. If the feds step in to save them it will cost so much that the government will have to finance a large amount of additional debt, some say almost doubling the current national debt over time, again pushing interest rates higher. This will put a significant damper on the real estate market one way or another.

  17. Kary, Great point. Condo owners should make sure they’re on the FHA approve list (if they qualify). Condo’s not currently on the FHA approved list may qualify for a spot approval.

    Condo HOA’s really need to watch how many NOO they have and make sure they have enough reserves or they’re in jeopardy of not having financing available to their complex.

  18. Hi Kary, I wrote more about making sure condos are FHA approved and what the basic requirements are here.

    If the FHA loan limits remain at the higher level, then it’s really worth HOA’s to seek out FHA approval.

  19. Are you a politician Kary?

    Here’s what you wrote last November…
    Wayne wrote: “If Countrywide, Fannie or Freddie go down, this nation as a whole will be in some Deep issues that Will Hit the Core of Almost Everyone in the nation. ”

    I’d agree with you as to the two FMs, but not CW. CW’s failure would just be bad for it’s employees and shareholders.

  20. No, I still think the failure of Freddie and Fannie would be a bad thing. The point I’m making is today’s news isn’t really news. There’s nothing in today’s news that indicates the situation is any worse than what the news was indicating last week or probably last month (although there may be more detail now).

    Even back in August I was probably saying the collapse of Freddie and Fannie would be very bad things.

    Let me tell you a bit about myself. Back in my high school days I worked Produce for Safeway. Every little tiny thing was a huge deal for management. Someone at regional would see something in a store, they’d yell at the store manager, the store manager would yell at the department manager(s), and they’d yell at the employees. And this could all be as silly as something like the butts showing on the peaches.

    In high school I worked for United Parcel Service. They run pretty tight schedules, such that if a truck from Seattle doesn’t make it out to the San Juan Islands by a certain point, or to the train station, boxes are going to be delayed. I remember one instance where a major conveyor belt broke, and the main guy was talking on the phone to a maintenance guy, and his comment was “hold your water!” He wasn’t panicked. He was going to deal with the issues in a calm reasoned manner.

    The markets are reacting to this news today as if they are Safeway management. They are panicking.

  21. I hear what you’re tyring to say… but you said this in comment #4:

    “This sounds like much to do about nothing. Doesn’t the government have to bail them out? Assuming they don’t have to, does anyone think they won’t? ”

    That’s all.

  22. But stock price would only matter if there was some idea that they could bail themselves out through an issuance of new stock. I don’t think that’s been on the table–but maybe I’m wrong on that. I don’t follow the companies that closely.

  23. off topic, but the new bookmark rollover is very annoying. you have to try and dodge around it to click on the comments link.

  24. BTW, deeplennon, thanks for pointing that thread out. I’ll point out to others not familiar with the zoo called Zillow forums that the person starting that thread once thought that the country was going into economic collapse because there was an export ban on pennies, and thought that Bank of America was going under because his cash machine didn’t work. And the next post after the one of mine quoted from that thread disagreed with me as to the effect of Countrywide going under.

    The thread is a good example of those who panic not being in touch with reality.

  25. Kary –

    The difference between “it might happen” and “its happening” is quite large, especially in the financial markets.

  26. b: thanks for the feecback. I used the generic implementation of the bookmarking tool, but I’ll try to implement where it doesn’t make leaving comments more difficult in the next round!

  27. I agree with Kary that panicking isn’t the proper way to react. I’m not sure who he’s suggesting is panicking. If I owned Freddie or Fannie, I would have sold a long, long time ago.

    I agree with b that the bookmark rollover is unfortunately placed.

    The Fed has pretty much shot it’s wad, already using over half it’s reserves to bail-out private banks, both traditional and investment.

    I’m not clear on how a government, who is currently 10 trillion in debt, can continue to sell debt with a dropping dollar at a low interest rate and expect other governments to be excited about buying it. At some point, and I don’t know what that point is, the government is going to need a bailout itself.

    So, with the GSEs both pretty much acknowledging they are insolvent, they can no longer raise cash themselves. So the taxpayer will need to pick up the bill. Is the taxpayer solvent?

  28. “I don’t follow the companies that closely.” -KLK

    Yet you still feel compelled to continue to provide your opinions about them.

    You are, of course, allowed to do that, but what’s the point?

  29. deeplennon, I don’t follow them closely in that I don’t know that they’re planning on issuing stock, as opposed to their usual means of raising capital–selling mortgages. This is the last news I read on them before today:–JwgrHPOwD91PTBE80

    It talks about them being well capitalized at the moment, but having issues if new accounting rules apply to them. It also mentions one of them in the process of raising $5.5 Billion, but doesn’t mention the source of that.

  30. Rhonda wrote: “Ben Bernanke just announced that the Fed’s discount window is now open to Freddie and Fannie (according to Reuters). Typcially this is intended for commercial banks.”

    They’ve also done that for some Wall Street firms. I’m waiting for them to open the window for members of NAR! 😀

  31. The value of their assets can drop less than 1% (which I suggest they already have and them some), and their cash reserves are wiped out. 5 trillion is a lotta assets, and when it starts moving in the wrong direction, it’s hard to stop.

    I think if they start sucking at the Fed teet, and they were forced to mark to market, they would wipe-out the Fed on Monday.

  32. Heh, Rhonda. I deposited it a few days ago. At least I think I did. Hard to be sure after buying some bread and milk for the boy! 😉

  33. Bili, it’s not like they have to pay out a dollar every time one of the properties collateralizing their loans drops a dollar. That would affect their balance sheet, but not their cash position.

  34. That’s true, Kary.

    If they were forced to carry reserves following the rules of other lenders, however, they’d have to shutter their doors.

    I’ve never contemplated buying them, so I don’t pretend to understand the intricacies of their accounting.

  35. I think I’m going to stall a bit longer before posting rates… I’ve been glued to CNBC. The Fed is now declining to comment on Reuters report of the emergency discount window being open to Fannie and Freddie. Once or if this is actually confirmed, it should have a positive impact on the markets and may increase rates.

  36. Pingback: Rates, Rumors and Reaction | Seattle Real Estate ~ Rain City Guide

  37. I don’t know if Ford is the greatest example. It’s at its 20+ year low.

    You know, I read a lot of negative blogs (I mean, negative outlook for the future), and it’s a good balance and gives good perspective, but they’ve been right quite a bit lately. I’ve made money shorting these banks and homebuilders, but if they go any lower things are going to be quite frightening.

  38. If housing prices continue to decline it is inevitable that Fannie and Freddie will have to raise more capital. Their capital reserves are too small to withstand any more significant write-downs (which would be required if US housing prices continue to decline).

    That said, no one should fear that Fannie or Freddie would actually go bust. The government would simply never allow that, and would step in with whatever resources were necessary to help recapitalize them (as many times as necessary).

    However, a government bail-out is bad news for investors since it would necessarily require a significant dilution of equity. The government would not stump up a lot of cash without demanding some pound of flesh (i.e. a portion of ownership in the agencies), and shareholders would take a drubbing. This is why the GSE share prices are hurting. So, if you hold GSE bonds, then you are fine (i.e. the government won’t let Fannie and Freddie default), but if you are a shareholder, look out since your equity may be wiped out in a government bail-out.

    More broadly, the implications of a GSE bail-out by the government would spook investors from getting close to anything that even smelled like real-estate. This would lead to a further decline in the value for non-GSE mortgage securities (i.e. which aren’t guaranteed by the government), and force even more write downs at lenders. More write-downs by banks will lead to a further conttraction in lending and a need for banks to raise more capital.

    In short, a bail-out of the GSEs would tank confidence in the financial system, make financing harder to come by in general, and result in further substantial declines in US housing prices.

    So, the if there is a bail-out of the GSEs, the last thing you would want to do is be buying a house since it would be a virtual certainty that prices were going to drop a great deal.

    Interestingly, a GSE bail-out will actually result in a substantial gain in market share for Fannie and Freddie. They would wind up with a near monopoly in mortgages (along with FHA). A GSE bail-out would basically be a flashing signal to all investors that the real-estate market was toast and that no one should touch ANY real-estate investment that wasn’t backed by the government (i.e. Fannie, Freddie, FHA, etc). The reluctance of investors to put money into any private real-estate underwriting will basically leave the GSEs as the lenders of first and last resort.

  39. By the way, I am a big fan of GSE bonds. They offer better interest rates than T-bills and are just as good (i.e. since they are backed by the same government as treasuries).

    Who cares if the housing market gets worse, or the GSEs need even more write-downs? They are backed by the government so it doesn’t matter one jot!

    Just stay away from GSE stock…

  40. It’s interesting to watch everyone scramble over this, but the reality is the damage is already done. At this point we’ll can only sit around and wait for the inevitable. Better regulation won’t clean up the bad loans that are already in the system and on the books. And given that the GSEs are operating at a loss, there’s little chance they can rebuild reserves and a capital base. So the question is how and when will they fail, and who gets to foot the bill?

  41. Scotsman wrote: “the question is how and when will they fail, and who gets to foot the bill?”

    There is really no mystery here. The GSEs will inevitably have to take more write-downs at the next quarterly reporting period, and will be forced to raise additional capital at that time. This will require a government bail-out since there simply won’t be any other investors willing to stump up.

    To be clear, though, the GSEs will never “fail”. The Government won’t allow it. The government will simply agree to give them the capital they need after the next write-down, and then repeat the process again when they make even more write-downs in successive quarters.

  42. Kary wrote: “If there’s a government bail out, I doubt shareholders would get a dime.”

    Correct. Which is precisely why a government bail-out would send a blazingly bright signal to all investors to stay away from ANYTHING related to real-estate. Any non-GSE related mortgage securities will depreciate even further, leading to even more write downs at institutions holding them.

  43. Kary,

    Good grief! The very mechanism that has enabled non-stop appreciation in housing has finally shown itself to be insolvent, and you are acting like this is just another BK.

    Securitization of mortgages has been the entire game over the past 20 years and it finally has run its course. Without securitization, local banks are going to have to scrutinize borrowers to ensure they are a proper risk. While I am sure you think this is a good idea, keep in mind that interest rates will have to be much, much higher for this to work. Also, there will be a lack of capital in the lending sphere that will pinch off growth, building, and appreciation. Not only that, but prices will have to be reset at a small fraction of their current list.

    My “20 cents on the dollar” thesis was based upon the GSEs making it through this mess. Without the GSEs, 20cents on the dollar is going to be the norm, rather than the semi-frequent exception. That $1.875M house on Port Madison – Bainbridge is going to sell for $250-$350K when all this is over.

    Why? Because loose credit and cheap energy, along with American hegemony over worldwide production made our present situation untenable. Now that credit is about to become prohibitively expensive, it will be very difficult to keep a massive deflationary spiral from taking place.

    Even if Uncle Sugar believes he can bail out the GSEs (he can’t), that action will choke off private access to capital markets. Your interest rates will be sky-high. The only scenario that seems to fly is a partial backstop of the senior debt, and a hope/prayer that default rates do not tick up.

    Even true Kool-Aid drinkers are smart enough not to believe that will hold. You would have to be free-basing the concentrate to be that naiive.

    This scenario is beyond my original assessment on how bad this would be.

    It is worse than I had anticipated. Ponder that.

  44. All the F&F news today is bad. I am gravely concerned. Anyone who’s ever worked in a corporate environment knows that rumors are not true until they’re officially denied.

    When conforming loan limits were raised and banks started off-loading their toxic crap onto fannie and freddie, there were some who immediately predicted that eventually, solvency problems would surface at F&F.

    Personally, I thought we wouldn’t see this until several years from now. Maybe 2012.

    Folks, we are still trying to work our way through the pay option ARMS originated in 2005, 2006 and 2007 which are only now starting to adjust.

    As much as I am against any government bailout, I fear that’s exactly what will happen.

    Next problem: FHA.

    Indymac: Gone. That was fast. From rumour to FDIC takeover in just a few days.

  45. I’m not as positive as you that the gov won’t allow their failure. The federal government is itself on the edge of failure when one takes into consideration it’s forward liabilities, and is effectively already insolvent. To think that they can just raise taxes, or sell more bonds, ignores the reality of external constraints. The feds loath the idea of higher interest rates, since they are a major cost in future expenses, and the world only has so much cash to lend. For the feds to borrow as much cash as needed to fully bail the GSEs would surely ramp up interest rates significantly, completely killing the economy as a whole, not just housing. And remember, the feds don’t legally back the GSEs, and are not required to make good on any of their debts. The guarantee is implied, but not required. The whole thing is akin to walking a tightrope, and the ultimate resolution far from certain….. IMHO.

  46. Eleua,

    Once fannie and freddie were allowed to buy toxic crap, my radar went off.

    Please help me out with this one:

    “The only scenario that seems to fly is a partial backstop of the senior debt, and a hope/prayer that default rates do not tick up.”

    I am the student and you’re the teacher. I’m listening.

  47. Eleua wrote: “The very mechanism that has enabled non-stop appreciation in housing has finally shown itself to be insolvent, . . …”

    Overstate the facts much? 😉

    One comment you made though sort of strikes a chord with me. The idea of going back to local banks for lending. I think I said this before, quite some time ago, but I find it a bit ironic that the system that was designed to smooth out the differences between parts of the country might end up destroying the entire country’s economy. I say that realizing that the failure of F&F (like the term BTW) would be disastrous. The thing is, I still don’t necessarily see it as all that likely. But assuming it did occur, most the local banks are gone! I wonder how many loans Homestreet could process every month? 😀

    One other thing. I see F&F’s situation being the reverse of the PMI folks. The PMI folks I’m guessing have largely exposure to loans that are less than a year old, since the 80/20s were so popular prior to August. That limits their current revenue, but also limits their exposure (and also their willingness to take on exposure). F&F should be so lucky. And FHA is cutting into F&F’s current volume, which I’m not sure whether that’s good or bad for F&F.

    Anyway, there are a lot of challenges ahead, but I still don’t see much substance to today’s news. Just rumor that got hyped and started panic.

  48. @Jillayne,

    Congress might attempt to be a guarantor of some of the more stable products produced by the GSEs, but not make good on every piece of toxic waste they have. This still preserves the structure and gives the appearance that the existing financing paradigm is still functioning. If the default rate ticks up, then the’s obligations would explode wtih it.

    Obviously, with the GSEs taking very little paper, the amount of financing available to potential buyers shrinks to a trickle, and puts even more homeowners underwater. This would certainly spike the default rates and shatter any illusion that the GSEs are still functioning. It is just an attempt to kick the can down the calendar a few months.


    I thank God in Heaven for people like you. If you don’t think there is much substance in today’s news, then I have to know what kind of mood-levelling medication you are taking. Cut your dose to 10% of current levels.

    The implosion of the GSEs is the “shaking of the Etch-A-Sketch” for all of the real estate financing and pricing paradigm. We will literally be starting over from “Square One.”

  49. Eleua:

    “It is worse than I had anticipated.”

    Agreed. I never imagined the GSE’s were going to collapse.

    Shock is the best description I have.

    Kary clearly understands the implications, but he’s in the denial phase.

  50. I think we’ll still have 30/20/15 year fixed but the interest only products may be gone. I would hope that a decent analysis will be done on which products performed the best.

    FHA offers fixed period ARMs… we have some facinating times in front of us. Just when you think you’re near the floor, the rug gets pulled.

  51. Rhonda,

    The GSEs are very large. Any “saving” will likely be more bark than bite, just to give confidence to Wall Street. In 3/07, we were told “it was all contained.” In 8/07, we were told that lowering the FED discount window was the solution. In 11/07, we had the mother of all SIVs and the various “facilities” at the FED. In 1/08, it was just a “rogue trader” that was papered over by another psychological boost by the FED dropping the FFT. In 3/08, it was all contained to Bear Stearns.

    I don’t know how much longer everyone will believe that the has the situation under control. Will the Lumpeninvestoriat believe that the GSEs will be bailed out and all will be well? Probably, but for how long?

    The model is unsustainable and no amount of intervention will matter over any significant amount of time. There is just too much damage that has been sustained, and we still have not even begun to reset all the alt-A portfolios that are out there.

    It is worse than you think.

  52. Rob-U-Blind wrote: “Agreed. I never imagined the GSE’s were going to collapse. Shock is the best description I have. Kary clearly understands the implications, but he’s in the denial phase.”

    Go through today’s news and find me anything that suggests that the collapse is likely. And by anything I mean financial figures that that actually means something. These things are publicly traded entities, which means there’s a lot of information on them. Anything even halfway specific is lacking from the news today, which tends to show it’s just hype. Again all we know new is that the government was making some plans.

    But I will say I did catch something that caused me concern. On NBC tonight Jim Cramer said he didn’t think the situation was all that bad. He’s a contra-indicator for me, so his statements cause me great concern (like when he said Seattle was still a great place to buy real estate.)

  53. Hi Eleua,

    Okay, thanks. I’m with you so far. However, default rates ARE going to continue to increase for quite some time. I am convinced of this. Nationwide and yes, even here in Seattle.

    There is no doubt in my mind that the GSEs are toast, I am just amazed that it happend so dang fast. Raising the conforming loan limits and allowing banks to send their crap to F&F was just a faster route to where we are now.

    It seems like the Fed is going to slowly lower us down into the abyss in a stair-step way. Instead of a big crash, it’s a slow spiral.

  54. Kary,

    Right now, I’m getting dinner on the table, but if I get the chance, I’ll post the numbers and how FUBAR the entire GSE model is.

    They are insolvent and have been for some time – just like IMB.

  55. “the GSE’s have not collasped (yet) and Bush is going to ride in and save them…I do not believe they will be allowed to “collaspe

  56. As far as I know, FHA is working, so why drastically change it?

    I think private mortgage insurance companies could be endangered because if HUD get’s involved w/taking over the GSE’s, wouldn’t they just use the same FHA model for mortgage insurance instead of the existing pmi’s that are all ready shakey?

  57. Entering a market where collateral (home) values are likely to be flat or decreasing, interest rates are going up as investors demand higher risk premiums, and higher rates are needed to attract limited cash to expanding needs, what does the “average” home loan look like?

    I’d guess 8-10% interest rates, maybe higher, and most importantly much higher down payments than we have seen. When your collateral is falling in value every day, how much margin do you need to feel secure? Will 15-25% be the new minimum down? What happens to the market then?

    I think this is all going to be much worse than many believe, and the government won’t be able to help.

  58. Jillayne, the first time I heard FUBAR was in a Kurt Russell move back in the mid to late 80’s…can’t remember which one…just remember he said it…which in the movie, it meant F@#3ed Up Beyond All Recognition. I’ll have to dig up what movie that was now.

  59. Scotsman, I think the government will have to try and help, (even if their efforts prove futile) which means the dollar will go down in value.

    In answer to your question, we return to manual underwriting, large cash downpayments, and higher interest rates. We may see the return of hard-money lending, more seller financing, but FHA won’t be able to handle the increase in business. They’re simply not set up for it.

    And we’re all forgetting that FHA defaults are in no better shape. WTF happens if FHA needs a government backstop?

  60. Rocky appears with Rambo to save the day and our banking/mortgage system. Come on, Jillayne, you said you saw ALL the movies. 😉

    Most recently, we have IndyMac that FDIC is involved with. Good question, Jillayne…guess we’d be FUBAR.

  61. Jillayne,

    What happens if there’s not enough money in the FDIC insurance fund to pay for all the bank failures?

    Answer: Total protonic reversal of the world’s fractional reserve banking system. Massive DE-FLATION in US currency.

    Right now, the FDIC has about $50B. That might cover Bank of America, but it won’t cover anything else. The FDIC can backstop Kitsap Bank or American Marine Bank, but the large, national banks would strain the system. Two national bank failures (BAC and WB) would completely gut the system.

    At that point, you would have a nation-wide banking run, as the backstop of the fractional reserve system would show to be all bark and no bite. This makes sense, given that the very idea that the is the insurer of all things financial creates a moral hazard.

    When I opened a checking account at American Marine Bank, I casually asked what their investment portfolio looked like, and they looked at me as if I was from another planet. They said that they “have no subprime” but they have lots of Bainbridge/Kitsap secondary mortgages.

    I just nodded and pretended that was perfectly consistant. I figured that if I tried to explain to the woman (who had a tongue stud) that secondaries are probably less stable than “subprime,” she would go on and on about how well they vet all their borrowers (without any real knowledge of that process). Needless to say, I have a grand total of $5 in their bank (not even worth the gas money to attempt to withdraw). I use thier bank as a convenient portal to move cash in and out of the national banking system (they don’t charge for debit card withdrawls on another bank’s card).

    Anyway…the moral to the story is that nobody even bothers to ask what their money will be doing in their deposit institution. Remember, when you make a deposit at a bank, you are loaning money to that bank. You need to ascertain if you will get it back. If Uncle Sugar says that he will make good on your bank’s promises, that’s fine, but it makes people avoid asking questions that they should be asking. Sometimes I think that is by design.

  62. As promised…

    About how hopelessly FUBAR the GSEs are, you might want to download this graphic to help you follow along.

    As you can see, at the end of 2007, FNM had a $2.1T (that’s TRI-llion with a “T”) of mortgages that it insures. It also has $724B worth of assets that it holds in the form of mortgages that it services and receives payments. By law, they have to have at least 3% of their assets in available capital reserves, which by these numbers would be $21.7B. They have $45B.

    So far so good, right?

    Well, they have to insure that entire portfolio of $1.2T, and that all comes out of that financial cushion they are holding. As long as defaults remain very low (real estate always goes up), then we have no problem.

    What could go wrong?

    Two things: First, the investment portfolio ($724B) and the debt ($796B) could get out of whack and cause a cash-flow problem that comes directly out of the $45B financial cushion. That is the least of their worries.

    The biggest threat is that massive $2.1T portfolio they are insuring.

    Let’s do a story problem, because “life is a story problem.” (with special thanks to Ralph Warton, my freshman calculus teacher in 1985)

    With an existing $45B cash position, and a $2.1T insurance obligation, assuming the investments and debt balance one another and do not weigh on the cash position, what is the maximum default rate FNM can sustain and keep their cash position at the government mandated 3% on the $724B asset portfolio?

    Show your work and neatness counts.

    (all figures are in billions of US dollars)

    $724 x .03 = $21.72 (required cash position)

    $45 – $21.72 = $23.28 (excess cash position)

    $23.28 / $2100 (x100) = 1.108% (maximum default rate)

    So, there you go. Now, if the performance of the asset portfolio wanes, then that will further erode the amount of defaults FNM can withstand.

    Now, I ask you…does anyone think the default rate is that low, or that it isn’t increasing rapidly?

    The natural response would be for the to just throw another $45B at the problem and it would be solved. That’s less than 1/6 of the latest stimulus checks that were put out there to keep Target and Wal Mart afloat. True, but what if the default rate increases by an order of magnitude? What percentage of the portfolio was written in the latest housing bubble?

    More importantly, how much dreck was thrown at the GSEs in the past year? Lots.

    Is Uncle Sugar going to continue to just monatize all the mortgages in the country? After all, that is what is doing by taking over Fannie and eating every mortgage that comes its way. If it does not, the available pool of money to support new home loans dwindles rapidly – very rapidly. This would create a buyer’s strike and would drive down the prices of homes in a fashion that would even impress me.

    Contrary to popular delusion, defaults on mortgages are not driven by job losses and medical SNAFUs. In a down market, they are driven by a home owner (or investor) looking at what he owes and what he can sell for, and then deciding to give it back to the bank.

    That’s why the GSE model does not work. It was a moral hazard in the beginning and could only work as long as….

    “…real estate always goes up.”

  63. Ah, but it gets better. Of the $45B they have in assets, about $13B is TAX CREDITS against future earned income. Now , if they aren’t earning anything, those credits are pretty worthless to say the least. And more importantly, they really can’t be used to pay off against any future losses. A tax credit may be a nice thing to have, but last I checked QFC and ARCO weren’t accepting them in lieu of cash, and they probably won’t work very well for paying off any losses.

    In short, the cash equivilent assets are overstated, and the condition of the collateral is probably worse than they’re letting on. Given that, and their 1.1% allowed default rate, they are already beyond insolvent and well on the way down the drain.

  64. It’s not going to get easier to obtain a mortgage loan, that’s certain. Products will be limited, rates will be higher and underwriting tougher for conforming mortgages.

  65. Eleua, thank you, it was interesting, but that’s not quite what I asked. Rather obviously these things could tip over. But my question was what in the news of yesterday indicated that was any more likely or even close to being imminent. Your material just shows who the system works, and what might make it tip over. But unless I missed something, you’re not even showing that their situation is worse now than a year ago, or the beginning of the year, or last month. So if you have something there, I’d like to see it.

    And BTW, correct me if I’m wrong, but let’s say they have defaults that get them to the trigger point of needing more capital, can’t they just sell assets to generate cash? That presumably would create income problems down the road, and thus is only a short term fix, and when they needed to do that might not be the best time to sell the types of assets they hold, so I see a lot of downsides, but isn’t it possible.

    Finally, this doesn’t pertain to what you wrote, but in a lot of articles I see mention that their capitalization requirements are not as high as regular banks. The reason for that is sort of obvious from this week’s news. Arguably what brought down IndyMac wasn’t bad loans, but a bank run. As far as I know, F&F don’t have that type of risk, so they don’t need to be capitalized to protect against it.

  66. @Ardell – LOL! Yes, we do now give a RA about the banks.


    I need to get the most recent financials on FNM and see what their positions are for the 2Q08. I’ve got a very strong hunch that their default rates are well beyond what they have been historically, and that their ‘mortgages held as investment’ are probably undeperforming against their debt obligations.

    Do I know the exact amount? No. However, if the were on a razor thin margin 6 mos ago, I’m going to go out on a limb and say that their margin is even thinner as we begin 3Q08. I’m guessing the dim bulbs that invest in FNM have also gotten the same hunch.

    Could they sell assets? Sure, but if you look at the market for MBS, ans that the only ones that are worth anything are those that are issued by FNM on the assumption that FNM is solvent, you could easily see how something that would normally be sold for par or par+, could now only fetch 40-60c on the dollar for AAA rated stuff. Selling those causes an immediate capital impairment, to say nothing of that $796B of debt that is still weighing on that $45B cash position without the $724B of investments to offset the debt obligations.

    If you have $100K worth of income from your $2M bond portfolio, but you also have $95K worth of debt service, and interest rates just shot up, your bonds are not going to be worth what they were when you bought them. Selling them may make ends meet for a month or two, but if you sold 20% of your bonds, your income would likely fall to $80K, but you still owe $95K (assuming you are dealing with fixed rate bonds and debt). Selling your assets into a discount only helps for a short time. Now, you have the debt alligator closing in on the canoe. That’s why selling assets doesn’t help FNM that much.

    While a bank run did bring down IMB, that didn’t start until July 8. IMB was actually brought down by their loan portfolio, which destroyed their capital position. This is the problem with most of the banks in the US, not just IMB. A grizzly analogy would be a man standing on a trap door with a noose around his neck. I would argue that the man is doomed once the lever is pulled, even though he has a length of rope to travel. Yes, it is the abrupt tug of the rope that actually kills him, but that is a mere formality, as the setup is fatal.

    I would argue that FNM has been travelling down the rope and is nearing the full length. IMB reached the end of the rope this week.

    The GSEs need more capitalization. They are essentially insurance companies and their risk assessment is FUBAR. Their entire model is based upon the premise of “real estate always goes up.” That being the case, they took on too much for their amount of capital. Default rates are going to be much, much higher. How high is anyone’s guess, but my guess is the stuff that was written in the past 6 years is going to default well north of 25%, while the older stuff will likely slope to double of historical rates.

    If 1/3 of that $2.1T portfolio is recent (and I’m just guessing), and they default at 25%, with a 40% recovery rate, you are looking at:

    $700B x .25 x .6 = $105B

    There is NO WAY that can be sustained without a direct taxpayer bailout, and that assumes the model still survives (which I doubt). I will also state that my assumptions are tame compared to the realities that we are seeing across the nation. 98% of foreclosures in California go to the bank with no bid.

  67. If the average hyped story of the press was accurate, by now 100% of the population would have herpes (stories from the 70s), except that the price of houses would be zero because everyone would be dead of aids (stories from the 90s), and going within 2 miles of salt water would result in a shark attack (stories from 2001). Very seldom do the worst possible scenarios come true.

    And again, by the time the press learns of an issue, usually the worst is either near or past. And that might be true here too. Look at King County real estate prices. You could make an argument that December 2007 was the worst, since it was lower than December, 2006. Or you could argue that it was February 2008, the recent low, even though that was within $100 of February 2007. Or you could argue it’s yet to come.

  68. >I feel the conflict within you. Let go of the Kool-Aid. Come to the ‘Dark Side.’ Join us.


    It’s nice over here, Jooooin us…….

  69. KLK –

    The problem with your analogies is that media overhype actually helps subdue those problems. In this case, the media overhype makes the problem much much worse.

  70. b–that’s true with health things, but not necessarily financial things. The hype caused Ford to fall more than is should have, which was good for buyers at the time.

    Also, I don’t really see how you say the hype is good. The really poor reporting of the credit situation has caused people who can get credit to think that they cannot. So the hype is making the situation worse, because it’s lowering property values more than they should be, because there are fewer buyers.

    The reporting of availability credit is probably a good example of how bad the reporting is in general. People thought 100% conventional financing went away much earlier than it did. And since then there’s been very little reporting on the tightening that’s occurred since. From reading the press you’d really have no idea at all what the situation with financing is.

  71. KLK,

    And again, by the time the press learns of an issue, usually the worst is either near or past. And that might be true here too.

    Words fail me.

  72. KLK,

    The financial news, especially CNBC, understates the dangers that lurk in the financial sphere. Their advertizers’ business models are all based upon “stocks go up in the long term” and keeping clients fully invested. Their job is to keep the sheep calm.

    Show me one mainstream financial news source that accurately stated the dangers that have presented themselves over the last 18 months. I can’t. The blogosphere got it right, and they are saying that we are not out of the 3rd inning.

    It is the financial blogospere that has been leading this, and we have been swimming upstream against the mainstream financial media.

    Ask Ardell who sniffed-out the banking crisis first: The MSM or the bubble-bloggers?

  73. I’d agree with not relying on CNBC for anything (but for different reasons), but I really can’t say the bubble bloggers got it right (or that they were the only ones warning of mortgage issues). If they’d gotten it right I’d be way under water on my October 2007 purchase. Meidan prices in my neighborhood are higher now than a year ago.

  74. KLK,

    I guess your home trumps the millions that are in foreclosure and disrepair around the nation. One area will be last to go, and it just so happens that Seattle is among the last three to tumble. When they do, they will tumble into an economy that is already in free-fall, unlike Boston and San Diego that tumbled into a fairly healthy economy.

    I wish you well. I know the power to see only what you want to see is very strong.

    Ask yourself, “Is my experience one that will be immune from the millions around me?”

  75. Eleua -re #100…I (and my husband) signed off this weekend and went tent-camping on Blake Island with 2/3 of our teens plus one teen-friend. I’ve been begging the family to go tent camping for years…this was our first time together. 🙂

    No internet, no TV and the only thing the newspaper was used for was to start our camp fire. It was great to be “unplugged”… especially after Friday.

    Looks like Jillayne (cheated!) googled the answer. 😉

    We’re just home now and unpacking…a lot of work for one night but tons of fun!

  76. I just received this update from MarketWatch:

    WASHINGTON (MarketWatch) — The White House and the Federal Reserve moved Sunday to prevent Fannie Mae and Freddie Mac from failing. In a statement, Treasury Secretary Henry Paulson said the global reach of Fannie [s:FNM] and Freddie (FRE:Freddie Mac Last: 7.75-0.25-3.12%
    FRE 7.75, -0.25, -3.1%) necessitated unprecedented action. The Treasury has moved to increase its existing line of credit to Fannie and Freddie. In addition, Treasury have been given the power to buy the two companies stock. In a separate vote, the Fed board of governors voted to open its discount window lending facility to Fannie and Freddie. In return, Paulson asked Congress to rework a measure in the housing bill moving through Congress to give the Fed a formal role to work with the new GSE regulator that the legislation would create.

  77. Rhonda,

    I just took my 9yo son to Blake Island on a tent camping kayak trip from Rockaway Beach on Bainbridge. It was my first time camping (I had done a swim from Port Orchard to there when I was in HS, but it was very relaxing and a good time with the boy.

    Regarding the gooberment action on the GSEs…they apparently will try to float some debt to help bridge the gap and then the US.treasury wants the authority to buy stock in the company.

    Wow! The market is presently liking the action, but there are several hurdles to clear before the money is generated. This being OPEX week and the meat of earnings season, I expect lots of .gov shennanigans and volatility on Wall Street.

    I don’t think the Congress has authorized the stock purchases, only that Skeletor wants the authority to buy the stock.

    I also think this was anticipated and we shall see if the market continues to run with this. The treasury dept also released a statement that they will not help out the ailing banks, only the GSEs.

    Why? They don’t have the money and they know it.

    Now, we get to play, “How dumb are shareholders and fund managers?” Given the recent history, I’m guessing pretty dumb. Expect a good rally, that will likely end very quickly.

    Bonds don’t like it, so far.

  78. Hi Rhonda,

    I didn’t cheat, I took a guess, posted my guess and THEN I googled it and got the right answer. Sounds like you had a fun get-away. Was it agonizing being away from the news?

    Kary, was this fast enough for you? I got word last night around 1130AM via my google reader that this was in the works for today…

    Here are updates from various news sources:

  79. Just in: Statement from James B Lockhart, Director of OFHEO (on a Sunday evening):

    “I support Secretary Paulson, the Administration, and the Federal Reserve in their efforts to stabilize the housing finance system.

    OFHEO will continue to work with the Treasury, the Federal Reserve, the Congress, and the Enterprises in addressing the current situation and to assure that the Enterprises continue to fulfill their mission. We look forward to rapid passage of GSE regulatory reform legislation.

    The Enterprises’ $95 billion in total capital, their substantial cash and liquidity portfolios, and their experienced management serve as strong supports for the Enterprises’ continued operations.

  80. So what happens to the shareholders? Do any of these plans ensure that there is no dilution of equity if any form of bail-out were to occur? If the GSE shareholders aren’t protected then we could see a complete abandonment of the financial system by investors.

    Who will want to buy shares in financial firms if the government isn’t goinng to ensure their investments remain safe? Just ask the Bear Stearns shareholders how happy they are. Any more government bail-outs like that and it’s game over…

  81. Eleua wrote: “I guess your home trumps the millions that are in foreclosure and disrepair around the nation. One area will be last to go, and it just so happens that Seattle is among the last three to tumble. When they do, they will tumble into an economy that is already in free-fall, unlike Boston and San Diego that tumbled into a fairly healthy economy.”

    You’re assuming Seattle will tumble. And people a year ago were saying it would tumble. And they were saying it would be before now. How long do we have to wait?

    But quite frankly I don’t care what happens to my house for the next several years price-wise. It’s not a big deal, and if I’d waited I probably would not have obtained a house on this particular street. The neighbors were a big selling point (very social, and they keep their property up).

  82. Well I guess will learn how “imminent” it was when one of them actually uses the line of credit, or borrows from the Fed. As it is, it’s clearly damage repair of the panic caused by the article.

    BTW, one thing I didn’t realize from the reports I read Friday was that one of them has a 3 billion bond offering Friday. I’ve seen that elsewhere since, but only unless I missed something, only the 4th of four stories above even mention that. That makes the timing of that article rather reckless, at best. The other entity apparently recently completed an offering of twice that size, so absent Friday’s news this one probably would have gone off without notice.

    It will be interesting to see how the offering goes tomorrow. I know there are ways of pulling back if things are not going well, but I don’t remember what they are.

  83. I just read on MSNBC (while I was looking for the latest news of Angelina Jolies’ babies) that the bond offering is of 3 and 6 month bonds. That seems very strange. Anyone care to explain that one?

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  85. KLK,

    3 and 6 month bonds?

    The .gov can’t throw a huge auction out there on their long term debt, or it might find out that nobody wants it at these rates. That kind of price discovery is not what they need

    Also, 3-6month money is easier to sell. My guess is Skeletor is calling in favors from the IBs so this gets fully subscribed. They will do the same crap in another 13 and 26 weeks. Lather, rinse, repeat.

    If you are a cynic, then look at the calendar and see what is 3 to 6 months down the road.

    Kick the can…

  86. To me, nothing screams “our banking system is sound and well capitalized” like the .gov going from crisis to crisis throwing money at the lynchpins of the US banking system.

    If this was a Hollywood production, it would be funny. Unfortunately…

  87. Eleua said: “The .gov can’t throw a huge auction out there on their long term debt, or it might find out that nobody wants it at these rates. That kind of price discovery is not what they need”

    Actually, I suspect that there might be surprisingly robust demand for US treasuries (both the long and short variety). Believe it or not but treasuries are percieved as being one of the safest places to park money these days. Heck, with banks like IndyMac failing who wants to put their money in term deposits anymore?

    My guess is that the demand for T-bills will be very strong for quite a while, keeping interest rates really low. Not that this will help much. The rates on all other forms of debt will continue to widen regardless. Just because there are low T-bill rates doesn’t mean it will be cheap for either businesses or consumers to get loans.

  88. Sniglet,

    Your theory is correct if you are discussing the short end of the Treasury curve. The long end of the curve is going to be the short of a lifetime when this gets rockin’ and rollin’.

    Flight to safety is only for the short term debt. I look at 30 and 91 day debt.

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