What's Going To Happen To Freddie And Fannie? What Does It Mean For Mortgage Rates?

Yesterday RealtyTrac published a good article talking about the debate currently going on in Washington D.C. about Freddie Mac and Fannie Mae. There are several moving parts in this whole ordeal that investors should be aware of. Rather than trying to regurgitate those for you here, we suggest you read the article from RealtyTrac.

It's mind boggling how much money the government is pulling in from Frannie and Freddie now. However, at the same time it feels like we've been down this road before. Mortgage rates can't stay this low forever, can they? Everything is rosy now, but what happens if this new real estate bubble that seems to be forming pops? As soon as mortgage rates start to go back to a normal range, what's going to happen to the housing market?

Housing values are being inflated thanks to historically low interest rates. When that 3.75% 30 year fix mortgage goes to 5%, all the sudden instead of being able to afford a $300,000 house, that same homebuyer will only be able to afford a $260,000 home. The housing market simply won't be able sustain current values once this rate increase happens. Then, just like we saw before, the snow ball effect will come into play and things will get exponentially worse.

If the government shuts down Freddie and Fannie, you can be that rates are going to increase a lot faster than they would otherwise. At the same time, though, this current model is not sustainable either, at some point it is going to crash, and the government is going to be on the hook. I suppose at least this time around the government gets to participate in the upside. Too bad they don't do a a better job of managing the profits.

Can Republicans Dismantle Fannie and Freddie?

A new proposal by three Republican senators aims to remove public support of the mortgage giants and require them to repay bailout money. Lauren Tara LaCapra from The Street explains why this proposal is highly unlikely to succeed. See the following article from The Street.

There are smart legislative proposals, and then there are smart legislative proposals that are doomed to fail. A pitch by leading Republicans to oust Fannie Mae (FNM) and Freddie Mac (FRE) from their taxpayer haven falls squarely into the latter category.

Sens. John McCain (R., Ariz.), Richard Shelby (R., Ala.) and Judd Gregg (R., N.H.) have proposed an amendment to the financial reform bill that would put an end to Fannie and Freddie's hybrid status as government-guaranteed, shareholder-owned entities. The proposal would accomplish this by simply winding them down, over a period of more than 10 years.

The McCain-Shelby-Judd amendment would also require Fannie and Freddie to repay the tremendous amount of support they will have received from taxpayers. One can assume that figure will reach at least $400 billion by the time their mortgage losses abate, since the Treasury Department lifted the firms' bailout cap from that level to an unlimited amount in December.

Imagine that: A privatized mortgage market, with no implicit or explicit taxpayer risk, and the largest bailout fully repaid. Keep imagining, because it's not going to happen.

It's hard to tell whether Republicans really want to reform Fannie and Freddie, or whether they're using the firms to further stall financial reform legislation. Either way, Democrats have made it clear that Fannie and Freddie are not going to be on the agenda until next year.

Furthermore, the Obama administration would like the government to keep playing a major role in housing finance, according to comments by Treasury Secretary Tim Geithner before the House Financial Services Committee in March.

That's unfortunate, and slightly absurd -- though perhaps unsurprising.

The head of that House committee, Barney Frank (D., Mass.), was arguably the man most responsible for Fannie and Freddie's collapse, apart from their management. Frank and his congressional colleagues pushed the government-sponsored enterprises further into subprime ahead of the housing market's collapse, famously shrugging off any suggestions that it might be a bad idea.

Frank now seems to take seriously the need for Fannie-Freddie reform, as does his senatorial counterpart, Chris Dodd (D., Conn.) -- perhaps because they have little choice. Dodd spearheaded the broader financial reform bill that's now being hotly debated in Congress. Republicans are hammering away at all fronts, and criticism has recently heated up in the media about the lack of any Fannie-Freddie reform proposal.

"It's not entirely surprising that [Fannie and Freddie] haven't been taken up in the Dodd proposals because it's going to be a more complicated issue with them," says Robert Hockett, an expert in financial law and economics at Cornell Law School. He adds, however, that "no set of financial regulatory reforms that didn't at some point address Fannie and Freddie could pretend to be complete."

But there's a wide gap between Democrats' idea of reform and Republicans'. Oddly enough, Democrats fall more in line with industry proposals that would have the government continue its deep involvement in the mortgage market. Taxpayers would still guarantee losses, just explicitly rather than implicitly.

What's more preposterous is Frank's recent deflection of criticism. In a memo to other Democrats, Frank said the GSEs have already improved their underwriting standards and implied that losses related to old loans are irrelevant.

"This is an important point that has to be repeated -- as Fannie and Freddie operate today, going forward, there is no loss," Frank wrote. "The losses are the losses that occurred before we took the first step towards reforming them -- we the Democrats -- and nothing we could do today will diminish those losses."

Right.

Dodd was another Fannie-Freddie cheerleader during the housing boom, but has stepped back from the debate as he prepares to retire in the fall.

The truth of the matter may be, as Barry Sloane, CEO of Newtek Business Services, puts it: "They were huge Fannie Mae and Freddie Mac proponents, and for them to say we need to shut this down, that would be admitting a legislative failure."

The Obama administration has been largely silent on Fannie-Freddie, too, seeming to think it's best to let sleeping dogs lie until after midterm elections. But it's not clear that ignoring Fannie and Freddie will win Democrats any goodwill -- at least not among voters who are old enough to recall the firms' recent history.

There were the Clinton-era hearings about Fannie and Freddie's inherent dysfunction as taxpayer-guaranteed, investor-driven entities. Then there were the accounting scandals of the early '00s. Then there was the ultimate collapse and the ensuing losses that have amounted to $145 billion to date.

Combine that profligacy with the wave of Tea Party fervor, widespread concern about the deficit, anger about financial bailouts and economic difficulties, and Democrats' pussy-footing around Fannie and Freddie may not help their cause much.

As one presumable Baby Boomer commented on an earlier TheStreet story about Fannie and Freddie: "In my crowd of angry old white men...the subj[ect] of these two 'agencies' come ups quite often."

On that note, it's worth considering how Fannie and Freddie have affected the political trajectory of certain politicians, via campaign donations. While the two entities have been barred from donating since falling under government conservatorship in September 2008, the Center for Responsive politics performed an analysis of Fannie and Freddie's campaign donations over the previous decade.

Dodd topped the list, with $165 million, followed by Obama, with $126 million -- a shocking amount, considering his brief stint in Congress vs. Dodd's more than a quarter century by that point.

Democrats received 57% of the Fannie and Freddie donations from 1989-2008, though the top 10 recipients were split evenly among Democrats and Republicans. Shelby, for instance, raked in $80 million in total donations, ranking at No. 9, whereas Frank came in at No. 26, with $43 million. McCain got $25 million; Gregg didn't receive any funds. The Washington Times' conservative editorial page also points out some interesting connections between the GSEs and former officials from the Clinton and Obama administrations that may have bought some good will on Capitol Hill.

In any case, Republicans are charging full steam ahead with their agenda to derail Obama's reform overhaul. And for one shining moment, political motivation seems less important than the ultimate goal: meaningful reform to the terribly broken housing-finance system.

Democrats will likely argue that the housing market is too frail today and too important ultimately to have the government step away.

It's true that Fannie and Freddie must keep playing their current roles for the foreseeable future. Otherwise, the housing market's nascent recovery would fall to shreds. But the McCain-Shelby-Gregg plan provides ample time for a full recovery, even under the most bearish forecasts. And few would argue that the private market couldn't step in to fill Fannie and Freddie's shoes over a period of at least 12 years.

"At the end of the day, it is extremely important that the private sector has to provide capital and be the bigger player in industry than the government," says Sloane.

On a philosophical level, when it comes to homeownership -- and losses that have resulted from recklessness of the past -- it seems time for a reckoning to come.

Eric Donnelly, managing partner of Urban Commercial Mortgage, has a suggestion for the American dream that ignores a borrower's ability to repay a loan: "Homeownership is not for everybody and there's a real argument to be made for renting."

Democrats in Congress and the White House should take note of that when structuring their counterproposal. Too bad they probably won't.

This post has been republished from The Street, an investment news and analysis site.

16,000 Homeowners Get Early Christmas Present From Freddie and Fannie

In an attempt to stop the flow of foreclosures that is ravaging the companies, Freddie Mac and Fannie Mae have decided to put a temporary hold on new foreclosures and evictions. This hold will last till early 2009 and is meant to give homeowners the chance to work out loan modifications, hopefully allowing them to stay in their homes. Between the two companies this move is expected to affect around 16,000 homeowners facing foreclosure, according to the Wall Street Journal. So it seems that these 16,000 homeowners are getting a nice little Christmas present from Freddie and Fannie, as well as from taxpayers I presume.

If nothing else, it will be interesting to see how this idea works. I was skeptical at best when the foreclosure moratorium was discussed during the presidential debates, and I still don’t think this will work as well as they are hoping. Nevertheless, this shall give us an opportunity to test the program on a smaller scale, which it could open up the door for similar action by other lenders if it works.

My problem with this strategy: I predict that ultimately the homeowners will still be foreclosed on, but they will enjoy some free time in their homes. If the homeowner doesn’t stay in the home, or somehow sell it, then the delay will just put the lender in even worse shape than before. Because in the case of Freddie and Fannie this equates to taxpayers taking on the burden, I’m not too fond of the idea. It will work out better if the companies are selective about who qualifies for a foreclosure delay, but if they offer it to all owner occupants it is doomed to failure. The problem is most people are in foreclosure for a serious reason: Some people lost their jobs, some can’t afford the payment (with or without loan modification) and some people are choosing to enter into foreclosure because they are so far underwater on the house. The last reason is becoming a huge problem, and really should be the one most feared in this scenario. At least I can feel bad for the people who lost their jobs, or possibly even the poor sucker who got an interest only ARM sold to them that they couldn’t afford, but it is hard to feel bad for someone who can afford the payment and just wants out of their contract. Why on earth would we want to give these people another month, two or three of free housing? If they aren’t going to pay their mortgage and just plan on working the system, why should taxpayers be stuck with the bill? We already have to deal with the fact that we are going to lose money on the foreclosure, so why add anything else?

It will be interesting to see how this all plays out. I have my doubts, and I hope that I’m proven wrong and that this plan saves taxpayers a bunch of money. But unless we are able to create a method to accurately identify the homeowners who want help and can be helped, this is doomed to fail.

Mortgage Rates Are Falling! Will It Be Enough To Save The Market?

As most people know by now, the government has seized control of Fannie Mae and Freddie Mac. While seizing any company comes as a bit of a shocker, in this instance it was not completely without warrant. One of the nice ramifications of the government seizure for homebuyers is that interest rates have fallen substantially, down around 0.5 percent so far. This translates into almost $100 a month in savings on a $300,000 loan. Savings like this could have an obvious impact on the real estate market.

The fact that people can now buy more house for the same monthly payment is definitely helpful for the market. As we learned in the housing boom, people don’t pay attention to the price they are paying for the house, but rather their monthly payment. This dynamic has likely changed some as people have become more cognizant of the fact that housing prices don’t always go up, but I would still venture to say that the monthly payment is still the primary focus for most residential home buyers.

The tricky thing with this new lower conforming rate is that a good portion of the population isn’t going to qualify. The new lending environment has changed greatly from a few years ago. It used to be that practically anyone could get a mortgage, but that just isn’t the case anymore. Credit score requirements are higher and income qualifications tighter. The net effect in all this is that fewer people can buy homes. Let’s now take into account the record levels of debt and late payments; one could venture to say that credit scores across the population are not as good as they could be. Again, this is a bad sign and it appears to only be getting worse.

The government appears to be pulling out all the stops to fix this housing problem. The new Housing Bill initiatives will become effective October 1, and they include several measures which should provide assistance to the market. Will lower mortgage rates and the Housing Bill be enough to right this failing market? Will job losses continue to increase and economic hardships make matters worse?

I don’t have the answers, and I don’t think anyone truthfully does. There are so many variables at play here that the best predictions are sure to be wrong. We will have to wait and see how this all plays out. As an investor, my advice to you is to stay diversified and keep a good portion of your funds in cash equivalents. This will allow you the flexibility to pounce on great opportunities when they present themselves.

Fannie Mae And Freddie Mac Seized

Probably the biggest news this weekend--alongside Tom Brady’s injury, if you are a football fan--was the report that the U.S. government is seizing control of Fannie Mae and Freddie Mac. There has been a lot of talk about this possibility over the past couple months, but I think the move was still a little shocking to most people. When we think of the U.S., we think free markets, and the seizure of companies definitely goes against that principle. While this might have come as a surprise to some, considering the bind we put ourselves in, this was the right move.

Typically I would be the last one to support the seizure of a company, but in this instance things are a little different. Obviously, the biggest difference is that in the case of Fannie and Freddie, taxpayers are potentially on the hook for trillions of dollars, with or without a government seizure. With this in mind, we needed to better align the goals of the company with the goals of the taxpayers. Since the taxpayers had little to gain from company profits, their only goal was that the companies don’t cost them any money. For too long, these companies had been profiting from an implicit guarantee from the government, allowing them to take on excessive risk.

How the current deal is set up with the companies is that the government has been issued preferred shares that are senior to all existing shares. This means that, in the event of liquidation, the government gets paid first. In addition, these shares pay out a 10 percent dividend yield, while at the same time the government cut the dividends for most other shareholders. This initial move did not require an injection of capital from the government, but the government has pledged to provide as much as $200 billion to the companies, according to the Wall Street Journal. The government also has acquired warrants which would allow then to acquire 79.9 percent of the companies for a nominal sum, according to the Wall Street Journal. Obviously, if the government were to exercise their warrants, the remaining shares would be so diluted that they practically worthless. The government has also ousted the companies’ leadership and placed the responsibility on the companies’ regulatory commission, the Federal Housing Finance Agency.

While my personal preference would have been to not offer the implied guarantee, followed by the actual guarantee in the first place, given our current circumstances, this move was in the best interest of taxpayers. Sure, it is going to cost us several billion dollars when all is said and done; whatever the number ends up being, though, it is likely to be less than we would have paid if we didn’t take over the company. At least in this scenario the government has some potential reward rather than only shouldered risk. The government hasn’t really put together a plan for how to deal with these companies over the long term, but I’d imagine it would involve some serious restructuring, which is definitely a good thing. Stay tuned for more information as things develop.

Should Fannie Mae And Freddie Mac Merge?

New York Times columnist Andrew Ross Sorkin proposed that Fannie Mae and Freddie Mac should merge in an article titled, "And They Could Call it Frannie." He stated that by merging, the new company could save billions each year on overhead, among other advantages. The article started by saying this is a “bold” idea, and I would certainly agree with that statement. I for one am certainly not a proponent of a Fannie and Freddie merger, but let’s take a little closer look at Sorkin’s arguments.

Sorkin estimated that “Frannie,” as he calls it, could save around $1.2 billion annually on overhead costs. That savings, in turn, would add about $18 to $19 billion in market cap to the new company overnight. The next savings opportunity comes with foreclosure servicing, where Sorkin estimated that the company could save an additional $300 million annually thanks to economies of scale. Of course, as Sorkin pointed out, one of the results of a merger would be the loss of hundreds--if not thousands--of jobs, but he also claimed that these job cuts are coming one way or another, as Fannie and Freddie look to cut expenses. The biggest benefit, in Sorkin’s mind, is that this merger would lower the likelihood of a government bailout and would cost taxpayers nothing.

Now here is the problem with Sorkin’s plan as I see it: Current circumstances have already shown us that these companies are too big and too powerful. The government has no choice but to back their debt; if they don’t, they know that the mortgage market will collapse, taking the real estate market and economy with it. Fannie and Freddie have repeatedly demonstrated that they operate knowing this government guarantee is there, which leads them to take excessive risks. In addition, both companies have suffered from leadership issues over the years. By combining these companies into one giant company, some risks would be increased. If the two companies individually already had too much power, how much power will they as a merged company have? How much increased leverage will this mega company have over the government of our country? The leader of this new company would instantly become one of the most powerful people in America. What happens if this leader turns out to be bad? If this company failed, it would most likely be a death blow to the economy and would pose a serious threat to our political stability.

We don’t need one mega company; instead we need to split these companies up. Just as it is good to diversify investments in order to spread risks, we need to think in the same way about these companies. We need to make it so that if any one of the companies fails, it doesn’t have as much impact on the country as a whole. We need to spread out our risk. Sure, this plan would likely lead to increased mortgage rates, as the smaller companies would lose the government guarantee, leading investors to demand somewhat of a premium on the debt, but the government shouldn’t be guaranteeing this debt anyway. In the short term this plan would require some adjustments, but considering the long term, it is the best solution.

Some Good News For The Housing Market Courtesy Of Freddie Mac

In a bit of bright news for the ever-gloomy housing market, Freddie Mac’s debt sale yesterday went better than planned. Freddie was able to sell $1 billion of 3 month bills and $1 billion of 6 month bills with relative ease, according to Reuters. This debt sale went over much better than the company’s last offering earlier this month, despite all the talk about a possible nationalization. This is great news for the real estate market because a poor showing at this debt offering would have led to higher mortgage rates for borrowers, which would have led to even more pressure on the floundering market. Fannie Mae’s debt offering is scheduled for tomorrow, so we shall see soon if they share a similar success.

Personally I have not been very high on Freddie Mac or Fannie Mae, and while it is a good sign for the companies that their debt offerings are still attractive, It does not cure the bigger problems plaguing the companies. The own a lot of mortgages on properties that are losing value. If values don’t correct soon, then they are going to face a huge number of defaults. I think we’ve seen pretty clearly that when people are upside down on their houses, they lose the incentive to pay their mortgages. The trend of how many people are going under is alarming, as evidenced in yesterday’s post about underwater homebuyers.

As long as the companies can continue to sell their debt at cheap rates, they should be able to weather the storm. The question is, how much longer will investors be willing to buy their debt? It is certainly encouraging for the companies that investors seem as confident in the debt offerings as they are despite the negative publicity, as this latest offering has shown. Investors must be under the assumption that the government will step in and save the companies if need be while still honoring each company’s debt obligations. The majority consensus about financial minds seems to be that if the government ends up nationalizing the companies it will indeed honor the debt, but would probably wipe out shareholders.

The result of this latest debt offering was definitely a positive for the housing market, but we will have to see if investor sentiment remains strong through the next wave of bad news.

60 Percent Of 2006 Western Homebuyers Now Underwater

2006 marked the peak of the housing market, and those who bought a home in 2006 likely owe more on the home than it is worth. According to a report issued by Zillow, 45 percent of all 2006 homebuyers are underwater, and almost 60 percent 2006 homebuyers in the West are upside down in their mortgages. The Western region of the U.S. has been hit the hardest, followed by the South, Midwest and Northeast. Of all the homes across the country--not just 2006--13.9 percent now have negative equity. The West leads with 18.2 percent of their homes having negative equity. The scary thing is that these numbers are expected to rise.

Zillow’s report predicts the peak for the percentage of homes with negative equity will be sometime around quarter two of 2009. According to their projections, the country will peak at around 16 percent. In the West, they foresee the peak at around 25 percent. This is an incredible number to think about. This would mean that one in four homeowners, regardless of when they bought their home or how much they put down, would be upside down on their home. This is obviously going to have a dramatic impact on people’s perceptions of their financial well-being. That will lead to lower spending, increasing the pressure on our economy, as well as more foreclosures as people cut bait and walk away.

On a positive note, existing home sales rose in July, exceeding expectations, but inventories grew and prices continued to drop, according to the Wall Street Journal. So the positive is that demand for homes is starting to return somewhat, but with more homes entering the market, that demand is not going to be enough to raise prices.

I think that the new housing bill, with its homebuyer tax credit and other aids, will help the market rebound, but it isn’t going to be enough to right this ship. This correction still has some fuel in its tank. There are also a few potential catalysts that could add more fuel to the fire, such as a Freddie and Fannie rescue/collapse and a possible recession with large job loss. If either of these things were to happen, not only would the predictions of a 2009 housing market bottom fall short, they could fall short by years.

Are You Ready For Higher Mortgage Rates?

Mortgage rates have been low for many years, but if things continue at their current pace, that isn’t going to last much longer. The biggest factor controlling the rates charged for standard 30-year mortgages is the price of bonds (called mortgage-backed securities) sold by Fannie Mae and Freddie Mac. Over the past few years, these bonds have been selling with an interest rate just a little higher than U.S. treasuries. Now, with all the problems being talked about surrounding Fannie and Freddie, investors are becoming more cautious. In case you need help connecting the dots, that means investors are requiring a higher spread on these notes. The more Fannie and Freddie have to pay to secure funds, the more they are going to have to charge to their borrowers; it’s that simple. The bigger question to think about is how these higher mortgage rates will affect an already suffering real estate market.

Probably the biggest single factor behind the housing bubble was the abundant access to cheap credit. More people than ever were buying homes because more people than ever could qualify for loans. This was in part because of law borrower credit standards required by lenders, but it was also in part because of the low interest rates offered. Homebuyers tend to focus more on the monthly payment than the actual purchase price of a home. If they know they can afford $2,000 a month, then they are willing to buy a home for up to that payment, whether it costs $250,000 or $400,000. With all these new buyers entering the market, and people now able to afford more home than ever before, this scenario created the perfect atmosphere for a run-up in housing prices. Now let’s look at present circumstances.

On a historical scale interest rates are still low, but compared to the interest rates during the height of the bubble, they are substantially higher. While interest rates are low compared to historical averages, housing prices are high compared to historical averages. With mortgage rates rising, along with the credit standards of lenders, we are getting the opposite effect of what we had during the bubble run-up. This means that we are decreasing the number of people who can buy homes in addition to decreasing the amount of home for which people can qualify. Obviously this is going to negatively affect the housing market. While we certainly have seen a sharp contraction in the housing market compared to what existed during the bubble’s peak, if mortgage rates continue to rise, you can bet that the contraction will continue and become even sharper.

Keep an eye on the investor confidence in Fannie Mae and Freddie Mac. If somehow the companies can regain this confidence, then mortgage rates could stabilize, but at this point that doesn’t appear likely to happen anytime soon.

Alan Greenspan Says Nationalize Freddie Mac And Fannie Mae

By now I think most people are aware of the blank check the government gave to Freddie Mac and Fannie Mae as part of the recently passed housing bill, but was this truly the best way to fix the problems of these government-sponsored enterprises (GSEs)? According to Alan Greenspan in an interview with the Wall Street Journal, this solution was “bad.” Instead Greenspan thinks that we should have nationalized the GSEs, wiping out shareholders in the process, restructure them and then sell of the pieces in order to form five to 10 private companies. Greenspan has long warned that the current structure of these GSEs threatened the nation’s financial stability, according to the Wall Street Journal, and Greenspan saw present circumstances as the perfect time to make a much needed change. Greenspan isn’t the only one with this opinion either; former Nixon Treasury Secretary George Shultz had these words of wisdom, as quoted in the same Wall Street Journal article: “If they are too big to fail, make them smaller.”

How the markets would react to the nationalization of the GSEs is up for debate, but Greenspan seems assured that things would be just fine. Right now the companies enjoy the full backing of the U.S. government, only the shareholders get to keep all the upside. So no risk and lots of potential for reward? Sounds like a pretty sweet set-up they have over there.

Typically, I’m not a big fan of government getting involved in business. I’ve always been of the philosophy that the market will work things out. But this circumstance is very different. The government has already intervened by granting these companies an official unlimited line of credit. We can debate whether or not they had one before, but now it is official. At this point, taxpayers are potentially on the hook for trillions of dollars; we have essentially taken on all the risk without the possibility for reward. This is obviously a horrible arrangement for taxpayers. While I don’t like the idea of keeping the companies under government control, that is not what Greenspan is calling for. He is saying that the government should take control of the companies only long enough to sell them off to private investors, who will form five to 10 smaller companies in the process. To me this plan seems much better then what we have in place. This solution also would work out much better in the long term, since it would increase competition. In addition, since there would be a bunch of smaller companies, we wouldn’t necessarily have to worry about a collapse in the market if any one of them went under. That means we wouldn’t have to bail them out if they made stupid business decisions, which is a winner in my book.

I don’t normally agree with Greenspan, but in this case I think he is on to something. The government offering up taxpayer dollars to keep two flailing giants afloat is a horrible plan, and the time has come for a change. Present circumstances offer us the chance to make a change and if Bush isn’t up to the task, I hope that the next president is.

Freddie Mac Says Enough Is Enough To New York

In what shouldn’t come as a shocker to legislators in New York state, but probably does, Freddie Mac has announced that they will no longer purchase subprime mortgages in New York state dated after September 1st, according to the Wall Street Journal. New York passed a law that will go into effect on that date that is meant to curb abusive lending practices, but which could also increase risks for lenders. Freddie Mac saw enough problems with the law that they said enough is enough, and decided they aren’t going to bother with it.

I’ve been saying for some time that many of these laws being passed are ultimately going to hurt the consumer, and this is just the first step. Freddie Mac is the second largest mortgage buyer in the country, and without them in the equation, bottom line lending costs for consumers will go up. Now, we can debate all day whether or not people should even be buying homes if they have to use subprime loans, but that is not the point. If the goal was to eliminate subprime loans, then they just should have done that; by passing legislation such as this, though, they are just going to increase the cost of the loans for those borrowers who do use them.

We will have to wait and see how this ends up affecting the real estate market in New York, but it certainly isn’t going to help it. I don’t know how popular subprime loans are there in the first place, but it is likely that low income areas will be hurt the most. Typically that is where subprime loans are most widely used. Investors who are looking to buy property in these low income areas should look carefully at the borrowing possibilities for potential buyers. If subprimes are out of the question, then you had better make sure that people can get a FHA loan, or that you are offering some sort of owner financing. New York may also not be the last state to take such steps as these, and it is possible that Freddie and possibly even Fannie Mae could take a similar stance to the new rules in the other states.

Freddie Mac CEO Ignored Warnings Knowing Government Would Bail Them Out

This is really not much of a surprise, but now we have official reports from company insiders that the CEO of Freddie Mac, Richard Syron, received and chose to ignore numerous warnings from within the company that Freddie Mac was taking on too much risk. A New York Times article published yesterday shared interviews from several current and former employees at Freddie Mac. They made it clear that Syron preferred to increase profits rather than manage risks. Here is a quote from one of the former employees interviewed in the article:

“'The thinking was that if something really bad happened to the housing market, then the government would need Freddie and Fannie more than ever, and would have to rescue them,' Mr. Andrukonis said. 'Everybody understood that at some level the company was putting taxpayers at risk.'”

Now, of course, Syron says that the company never assumed that the government would step in, but one would expect him to say that, especially under present conditions. The bottom line is that Syron--and, to be fair, other Freddie Mac executives--tried to maximize profits however they could and as a result, enjoyed some nice bonuses. According to the New York Times article, Syron’s share was $38 million. Meanwhile, the company’s market cap has lost around $80 billion and now the company is expected to cut their dividends by around 80 percent after the company reported a loss of $821 million last quarter, according to Bloomberg. The following is a quote taken from the same Bloomberg article:

“'This correction is more severe than what we've seen in the recent past,’ said Christopher Whalen, co-founder of independent research firm Institutional Risk Analytics in Torrance, California. ‘Both Fannie and Freddie are going to be profoundly insolvent by the time we're done with this.’”

Freddie Mac is also in worse shape than Fannie Mae because Syron chose to limit the amount of additional capital the company was to raise to--a much lower amount than Fannie Mae. He also delayed the latest $5.5 billion offering, and now because stock prices have plunged and investors are wary of Freddie Mac, the cost of that debt is likely to skyrocket, according to the New York Times. That being said, Syron still has a job, and now he has an official blank check courtesy of the U.S. government. Makes you feel pretty good as a taxpayer, doesn’t it?

Mortgage Fraud Still Going Strong And Taxpayers Will Get The Bill

Last Friday the Orange County Register published an article that uncovered the details of a recent real estate transaction which was blatant mortgage fraud and will likely be left on taxpayer’s plates. Reading this article just made me shake my head because it is apparent that banks have learned nothing from the mortgage mess we are in today. If you haven’t read the article I suggest you do so, but I will attempt to summarize it below.

An investor purchased the home on Camile St. in Santa Ana at a foreclosure auction for $304,500, about half of what the home had sold for in 2006. This investor then fixed the home up and flipped it to a Hispanic family for $625,000. On a street where homes are selling in the mid $300,000s, this sales price should be an immediate red flag. However, Wells Fargo which issued a $500,000 loan on the property, didn’t bother looking deeper into the deal. The investor sold the home as a for sale by owner and had a plan in place where he could offer a potential home buyer 100 percent financing, even though that is all but unheard of right now. As part of the sale, the seller paid the $125,000 down payment for the buyer, but that’s not all. The seller also agreed to pay the buyer $30,000 in cash, pay the first 3 months of the mortgage and buy them a 52-inch LCD TV. So the real sales price was around $460,000 once the seller concessions are taken into account.

The author of this article went so far as to call up the mortgage broker, escrow officer, appraiser and even Wells Fargo to get their reaction to the deal; it's no surprise, though, that they all brushed it off, saying the details weren’t their business and that it was between the buyer and seller. Wells Fargo declined to commit on this loan in particular because of privacy issues, but beyond that, the best they could come up with was that they have tightened their lending standards. I don’t know about you, but if this is their idea of tightened lending standards, then they have some problems. I sure hope that Wells Fargo uses this information to take some action against this sort of practice, but I’m not holding my breath.

It gets better though, the Hispanic couple who bought the home claim they were lied to. They said that they were told they were buying the home for $500,000 and that they were going to get 100 percent financing. They didn’t know about the $625,000 sales price till the end when they signed the papers. Translation: Either this couple didn’t bother to read the purchase and sale agreement when they signed it, or else they are lying in order to protect themselves now that this information is on the public radar. My take is it is probably option #2. This couple already owns another home on the same street, so this is not their first time buying a property. In addition, they admitted to noticing the price at closing, but agreed to sign anyway. I think an honest person would have questioned that then and there.

If you ask me, these buyers were in on the deal, along with the seller, mortgage broker, appraiser and escrow officer. They were wooed by the prospects of $30,000 in cash. All they had to do was sacrifice their credit. The investor would pay the mortgage for 3 months, taking away the chance of the bank red flagging the deal for further investigation if the loan goes non-performing right away. After that, the buyers don’t even need to bother paying the mortgage, they can just let it fall back into foreclosure and get lost in the crowd. After all, Camile St. is already a foreclosure haven; what's one more?

So the next question is, who is going to be stuck with the final bill when all is said and done? The buyer? The lender? That would be a no and a no. The buyer has nothing at stake in this deal; in fact, they were paid to buy the home. If you thought the lender, you are also mistaken, because guess what? This was likely a conforming loan. That means it is going to be guaranteed by Fannie Mae or Freddie Mac. Thanks to the new housing bill that President Bush signed into law yesterday, taxpayers are likely going to be the ones to take the hit on this one, as well as for other mortgage frauds out there. It is disheartening to see that obvious cases of mortgage fraud are still occurring. But now that we as taxpayers are ultimately responsible for the bill, this just makes me mad.

Housing Bill Signed By Bush; Now What?

President Bush signed the housing bill this morning, so the biggest housing legislation in decades is now officially on the books. The bill finally came together when opposing sides were able to agree that the bill as is was better than nothing. Republicans got their Fannie Mae and Freddie Mac support and Democrats got their foreclosure bailout. Neither side is 100 percent happy, but then, when does that ever happen in politics? So now that this housing bill is official, what happens? Can we expect to see dramatic changes in the housing market for the better now? Well, not exactly…

It is no secret how I feel about the housing bill, and if you aren’t familiar with my blog, read this prior post on the housing bill to get caught up. There are also officials who share my same discontent for the bill. According to BusinessWeek, a top official in the Bush administration admitted that this housing bill will probably help fewer people than the previous expansion of the FHA. This new housing bill is estimated to help around 400,000 people, compared to the previous FHA bill, which was slated to assist 500,000. This news, of course, made me even more upset because the FHA bill certainly didn’t live up to its billing (see previous post about FHA Secure loans). It turned out that many of the people the FHA bill helped were people who really didn’t even need the help, but instead elected to take a nice little government (read: taxpayer) subsidy for their mortgage. So if this new housing bill is going to help even fewer people, and cost us more, then pardon me if I don’t exude excitement.

I’m not sure of the exact cost of the bill, and to be honest, no one does. It ultimately depends on how many insured loans go bad and whether or not Fannie and Freddie will need the assistance that we are now offering. Estimates from the Congressional Budget Office put the price tag on the Fannie and Freddie package as high as $25 billion. As far as how many of the $300 billion in new FHA loans will go bad, your guess is as good as mine, but I’d assume it will cost us a few billion. In addition, there is a $3.9 billion foreclosure bailout provision included, along with a tax credit for first time homebuyers. I don’t know about you, but all the uncertainty of potential costs is a little scary to me. Sure, officials have made estimates, but those are just that: estimates. This is the equivalent of dropping your car off at the repair shop and getting a repair quote of between $500 and $10,000, but in order to get the repairs done, you have to agree to pay the final tab, regardless of where it might end up. I guess when you have debt approaching $10 trillion, what’s a few billion more?

The World Won’t Let America Fail

An interesting article was published yesterday in the International Herald Tribune titled, “Is America too big to Fail?” In today’s world of globalization, the U.S. has been borrowing hundreds of billions of dollars from foreign countries, and while these countries of course expect to be repaid, it is doubtful that they are ready to take any drastic actions that could jeopardize the U.S. The author made several points about how countries have repeatedly bailed out companies deemed “too big to fail” and believes that the U.S. falls under that same category.

One of the most interesting points made in the article is how the U.S. for years has condemned countries for bailing out companies and interrupting the free market forces, yet the U.S. does the same thing. The most recent example of this is with the legislation that U.S. officials are working on to rescue Freddie Mac and Fannie Mae if needed. The whole point of the free market is that only the strong survive. By allowing the market forces to take their course, weak companies will get weeded out and it will force those remaining to be more diligent about how they are run. If you set the expectation, though, that the government will step in and bail companies out if needed then it allows the companies to be lackadaisical and take undue risks. By supporting companies that should have failed, we are only supporting poor business practices.

The problem is that fear of job loss and economic setbacks proves time and time again to be too much for governments. I’m not sure if that has more to do with the politicians' and other officials' true beliefs for what’s best for their countries, or if they just can’t see past their term in office (feel free to toss in your favorite Alan Greenspan joke here).

This might actually end up working out in our favor, though, considering that foreign governments are begging to make the same arguments in regards to supporting the U.S. China and Japan, for example, which are the two largest debt holders of the U.S. have a lot at stake in regards to the U.S. economy. These countries make a large portion of the goods sold to American consumers, so a slowdown in the American economy could potentially cost them a huge number of jobs and have a drastic effect on their economies. If they continue to buy American debt, though, and finance more buying of their stuff then things go on all nice and rosy--at least in the short term. The question is how long are these countries going to be content allowing the U.S. to buy their goods on credit? When will they finally draw the line? Just as when you bailout a flailing business you have to ask yourself, “what am I ultimately encouraging?” And whether they are actually going to turn things around or you are just going to be faced with bailout after bailout in the future. At what point do you cut your losses and move on? At least in the short term it is unlikely that our foreign creditors are ready to cut the bailout lifeline quite yet. Whether or not that is a good thing, though, for them as well as us, remains to be seen.

Freddie Mac And Fannie Mae Bringing Fear To Investors

Yesterday, former St. Louis Federal Reserve President William Poole was quoted by Bloomberg as saying Freddie Mac and Fannie Mae were insolvent, followed by reports that the Bush administration was working on a possible bailout—the culmination of a very bad day for the two companies. Freddie saw their shares fall 23.2 percent, and Fannie’s shares shed 15.4 percent. The government will certainly come to the aid of the two companies if push comes to shove, but there is speculation that a government bailout could leave shareholders with little to nothing according to the Associated Press.

I’ve been harping the potential fallout of a Freddie and Fannie failure for some time, and it is a scary to contemplate. A failure of one or both of these companies would have serious consequences in the real estate market, the economy and of course tax payers. Some estimates have put the price tag on a potential bailout at over $1 trillion. With the current state of the economy as well as the national debt (over $9.5 trillion) this is a number that could cripple us.

Now that I have painted this doom and gloom picture, you should know that most people still think a bailout is unlikely. Here is a quote from a Wall Street Journal article this morning: “The government doesn't expect the entities to fail and no rescue plan is imminent. Government officials and market analysts expect both companies will be able to raise large amounts of capital relatively easily.” The two companies have been raising billions of dollars in additional capital to shore up their balance sheets, and analysts believe that they will continue to do just that if necessary. This strategy will dilute the holdings of existing owners of the company, but it appears to be the best strategy at this time.

I’m certainly not daring enough at this stage to invest in Freddie Mac or Fannie Mae, and though I do think the chances of a government bailout are increasing I don’t think it is the most likely scenario. Readers of this blog know that I like to plan for the worst and hope for the best, and I think this falls right in line with that. I’m starting to consider what might happen if the two giants were to fall, and specifically how it would affect my investments. I wouldn’t take any drastic measures at this point, but it doesn’t hurt to have a plan, just in case.