Ok. Enlighten me as to where I am going wrong. I am certainly not above making mistakes (God knows I’ve made some big ones). I have re-read Jillayne’s post and don’t see anything there that seems to contradict what I am saying.

Your powers of prediction based on what you read is amazing, but your lack of understanding how things actually work discredits you.

Check what you said about GSEs “making” loans and “tightening” credit standards.

Again, go back and read Jillayne’s comments.

Ominously, the treasury department has stated that they don’t care about GSE profitability.

“Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking.”

The treasury has also said they are going to buy large amounts of new GSE bond issues to help prop-up the real-estate market. This cearly demonstrates that they really aren’t interested in protecting the GSE portfolios, they are trying to bail-out US home-owners. You could argue these are one and the same thing, but they really aren’t. It’s in the GSE interest to improve the quality of the loans it makes and to charge higher rates for them. The government, however, wants to keep quality and rates low. Look at how irate the government has been that the GSEs weren’t buying enough Jumbos, and were tightening some of their lending standards. The Treasury Secretary, as well as senators have giving tongue lashings to the GSEs in recent months for not following through on the legislation passed earlier in the year that allowed them to expand their Jumbo business. Is it any wonder that the GSEs wound up going bust when they are being pushed to make mortgage credit easily available to everyone and sundry?

How does it really help us to put MORE people into homes they can’t really afford, setting them up for default and foreclosure?

I predict that this crisis won’t end until the government stops trying to bail people out. It is only at that point that the markets will finally be able to discover a clearing price and begin to recover. Will this be painful? ABSOLUTELY!!!! But it has to happen at some point, and I’d rather it be now rather than several years from now, after the government has spent a trillion dollars buying mortgage securities.

As far as other lenders that are set to go bust, some of the first on the chopping block are: WaMu, Lehman, Citigroup, Wachovia, Merrill Lynch, and Morgan Stanley. There are many more (particularly smaller institutions), but these are some of the biggiest. The first 3 in my list are already on their death-beds. The best way to tell which institutions are in the most trouble is to look at the cost of their credit default swaps (i.e. the cost of insuring their bonds). It now costs 40% of the value of the bond to get insurance on WaMu debt. The firms with the highest CDS rates will be the first to go under.

How the defaults actually take place is a messier picture. In some cases I expect to see more shotgun weddings ala Bear Stearns (i.e. where JP Morgan bought them for a song, with the Fed providing the financing, and asset guarantees). We will also see outright government take-overs. In fact, complete government take-overs are likely going to be the norm since there is almost no one else who would even want to buy these dead husks anymore (look at how Lehman can’t find anyone who wants to bite).

We have yet to see a conservatorship of an investment bank yet, but I’ll bet anything that we will start seeing them soon. The government is just too terrified to allow one of the IBs to go under.

Unfortunately, we are only in the first inning on this. Things have barely even gotten started yet in this credit crunch.

What makes you think the government will continue to run F&F the same as before?

Also, what banks can go belly up and how will they be absorbed?

In the short-term, yes, we WILL be moving towards a state-owned financial system, with the government taking over ownership of every lender that is “too big to fail” (which is most of them). Private lending will completely squeezed out until the government sheds all these financial institutions it will be acquiring (and it is JUST getting started: CitiGroup, WaMu, Wachovia, etc, are coming soon).

Sure, many existing banks will go bust if they have to mark their assets to market. The GSE bail-out likely saved many existing banks from immenent bankruptcy. But my point about how the GSE seizures make it harder for private lending to be profitable still holds.

Think of a new bank that starts from ground zero today: they raise several billion in capital and have NO toxic assets on their books at all. It would be much easier for this newly minted lender to start making money if the government didn’t own the GSEs. Without the subsidized government competition, this new bank could start lending to HIGHLY qualified borrowers and still charge highly profitable interest rates (10%, say for what would be a conforming loan product today). This bank couldn’t care less that the OLD institutions were pretty much insolvent.

At some point most of the existing financial institutions are simply going to have to close their doors since they are already insolvent. The new banks that emerge will then be able to start lending profitably once again.

The only thing the government bail-outs achieve is to delay the day when private finance can begin again. I do believe this will eventually happen, but only after the tax-payers have finally decided they simply will NOT fund any more bail-outs, and the government becomes unwilling to expand it’s balance sheet any more with bail-outs. We aren’t there yet…

“Think of it this way: if the GSEs went bust, then consumers wouldn’t have any choice but to go to private lenders for mortgages. The way it is now, there is no way a lender can get away with an 8% mortgage on anything that is GSE conforming. However, without those subsidized GSE mortgages as competition, private lenders could actually charge realistic rates (i.e. that were highly profitable).”

It’s the other way around, if the GSE weren’t around right now, banks would have no way to shed loans off their balance sheet. A lot of them would go belly up.

“Banks have actually been griping about the unfair competition from the GSEs for years (i.e. the fact GSEs can sell bonds to investors for more attractive rates than they can), so this is not just something I am making up. Also, many banks have said that the primary reason they jumped into construction loans and sub-prime was because there just wasn’t any money in underwriting conforming loans (i.e. the competition was too intense which drove down profitability).”

Banks whined about GSEs because they started treading into their territory like Jumbo loans. This was a complaint about the business model/role of F&F.

“As far as the government issuing (and buying) “gobs” of GSE debt, I thought I thorougly covered that with my quote from the treasury department FAQ. “Treasury will begin later this month by investing in new GSE MBS, which are credit-guaranteed by the GSEs” I don’t know how I can make this any clearer”

Well, duh! This is what’s needed to keep them operational. It’s the natural activity of a takeover. The bigger issue is how will they inject capital and how will they manage the business model of F&F in the near term.

“As far as non-conventional bank loans go, it is already very tough to find any non-conventional loans on offer ANYWHERE. To my knowledge, private subprime mortgage offerings don’t even exist right now. This proves that there simply isn’t any demand for non-conventional loans at the rates that lenders would want to charge for them.”

This is true for the short term, maybe for the next few years, but you can’t possibly believe that this is the model for mortgage origination and for that matter, banking in general going forward!? Think about it man. You really think we’ll be moving to a state-owned economy?

Think of it this way: if the GSEs went bust, then consumers wouldn’t have any choice but to go to private lenders for mortgages. The way it is now, there is no way a lender can get away with an 8% mortgage on anything that is GSE conforming. However, without those subsidized GSE mortgages as competition, private lenders could actually charge realistic rates (i.e. that were highly profitable).

Banks have actually been griping about the unfair competition from the GSEs for years (i.e. the fact GSEs can sell bonds to investors for more attractive rates than they can), so this is not just something I am making up. Also, many banks have said that the primary reason they jumped into construction loans and sub-prime was because there just wasn’t any money in underwriting conforming loans (i.e. the competition was too intense which drove down profitability).

As far as the government issuing (and buying) “gobs” of GSE debt, I thought I thorougly covered that with my quote from the treasury department FAQ. “Treasury will begin later this month by investing in new GSE MBS, which are credit-guaranteed by the GSEs” I don’t know how I can make this any clearer.

As far as non-conventional bank loans go, it is already very tough to find any non-conventional loans on offer ANYWHERE. To my knowledge, private subprime mortgage offerings don’t even exist right now. This proves that there simply isn’t any demand for non-conventional loans at the rates that lenders would want to charge for them.

You made several assumptions about the F&F bail out:

1. Banks won’t earn enough profit
2. No one will take out a non-conventional bank loan
3. The government will issue gobs of debt through F&F

I’d like to uderstand why you think these are the direct result of the bail out.

Yes, I understand that the government is bailing out the GSEs due to the fact they are under-capitalized. I also realize the government is making a capital infusion into the GSEs.

That said, the treasury department is CLEARLY saying they are going to start purchasing GSE debt as well. The quote I cited earlier is very straight-forward on this point.

You’re confusing debt versus capital. Capital was the reason the for the bail out.

You should read Jillayne’s comments a little closer.