off topic (somewhat) : Freddie Mac and the US taxpayer


D

darkness

(hope this is not *too* political for this NG. I really *don't* want
to start a political argument). Moderator will bounce it, I guess if
it is ;-).

Given that future taxpayer bailouts are a major issue in financial
planning (tax rates, and also the money available for medicare, etc.)
I think there is some relevance.

Just to encourage American readers to write/call/email their
congressman on this one. Many of you will realise I am something of a
free-market but socially liberal type so this is completely out of
character but on this one I stand foresquare alongside US conservative
congressmen (as does at least one Chairman of a Federal Reserve Bank):

the bottom line is Freddie Mac and Fannie Mae smell like Savings and
Loans debacles in the making, only 5 times the size. Their
outstanding mortgage bonds are already as much as US treasury debt
(query that? about 1.6 trillion in the case of the GSEs?). You have
two entities which make use of implicit government debt guarantees, do
not have the same disclosure or capital requirements as private sector
financial institutions, are growing like Topsy and have toothless
regulators. Oh and make extensive use of complex interest rate
derivatives (anyone remembering Orange County? but those were
*simple* interest rate derivatives). Remember how far the S&Ls had
their talons into the Senate? This smells like a big time financial
disaster in the making.

In the case of the S&Ls there was an easy chance to shut them down in
the early 80s, with limited costs to the taxpayer. Instead, they were
allowed to gamble their deposits on the most speculative assets, while
the regulators were prevented from intervening.

On the GSEs, in 20 years we could easily look back and wonder why
nothing was done.


INTERNATIONAL ECONOMY & THE AMERICAS: Mortgage giants Fannie and
Freddie look likely to escape deepest of reforms
By Peronet Despeignes
Financial Times; Jul 01, 2003


When Freddie Mac, the US mortgage giant, was hitby an accounting
scandal anda management shake-up last month, Richard Baker saw a great
opportunity. The Republican congressan from Louisiana has, for a
decade, campaigned for greater transparency, stricter regulation and
an end to special government-chartered privileges for Freddie Mac and
Fannie Mae, its "sister" institution.

Mr Baker, who heads the House of Representatives financial services
subcommittee that directly oversees the government sponsored
enterprises, or GSEs, even told the FT at the time that "any of a
number" of House and Senate Democrats had offered supportive comments.
"I haven't had anyone say to me that we shouldn't do anything," he
said, adding that he would take full advantage of the "window of
op-portunity" that had been created.

But when Mr Baker introduced a bill last week to strengthen
regulation, not one Democrat was named among its 20 co-sponsors. And
at a recent subcommittee hearing, several Democratic members expressed
strong reservations about any new legislation.

In anticipation of the difficulties of passing root-and-branch reform,
Mr Baker has lowered his sights substantially. He and other
free-market conservatives in the past advocated revoking the GSEs'
government charters, cutting off their lines of credit to the Treasury
and ending their exemptions from financial disclosure.

But in this bill, his goal is to strengthen the mortgage regulator, to
turn it into something Congress could go back to for more
authoritative advice and more competent action. That falls far short
of what some free-market conservatives want - and even under the most
favourable circumstances it could take years.

Freddie and Fannie have cultivated a powerful circle of friends on
Capitol Hill. Freddie Mac ranked 11th last year in campaign
contributions to congressional office-runners. Fannie was 39th. The
top recipients of Freddie money are all Democrats who sit on the most
relevant committees in the House and Senate. The executive staffs of
both organisations are dotted with well connected former staffers from
Congress and the Clinton and both Bush administrations.

Freddie Mac's board of directors includes William Powers, former
chairman of the New York Republican party, and David Gribbin,
long-time aide to Vice-President Dick Cheney. Franklin Raines,
Fannie's chief executive, was former president Bill Clinton's budget
director.

Fannie and Freddie's perceived government backing and special
exemptions allow them to borrow funds more cheaply, to invest in or
guarantee home mortgages. The results are fatter profits for the GSEs
and cheaper and more readily available mortgages for homeowners. But
for years, officials have worried the two may have grown too quickly
and become over-leveraged risks to the financial system and the
government. Their publicly held outstanding debt, which has grown at
double-digit rates over the past few years, rivals that of the US
Treasury.

Andy Laperriere, a public policy analyst at ISI, a New York
consultancy, says the GSEs' strongest argument in the past was:
"What's the problem? We're well managed, everything's fine. Obviously,
recent events call that into question."

But in spite of their latest travails, the GSEs may not be hauled over
the coals by Congress. Fannie has said that it expects the Senate to
block any firm proposals that emerge from the House and it is unclear
how much, if any, political capital the White House is willing to put
at risk. The US Treasury has only said that it is "still reviewing" Mr
Baker's bill.

The US has historically singled out home ownership as a social good
that merits special support. As Robert Mitchell, former president of
the National Association of Homebuilders, said in 2000: "During many
administration and many Congresses, our policymakers ...have
determined fostering homeownership is a very positive social and
economic policy."

The big question is whether the current arrangement is the best and
safest way of providing it. There is more doubt now about this, but as
a general rule, congressmen usually do not bite the hand that feeds
them - and American democracy has a habit of putting off tough
decisions.
 
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T

texsupport

darkness said:
<cutting lots of stuff>
the bottom line is Freddie Mac and Fannie Mae smell like Savings and
Loans debacles in the making, only 5 times the size. Their
outstanding mortgage bonds are already as much as US treasury debt
(query that? about 1.6 trillion in the case of the GSEs?). You have
two entities which make use of implicit government debt guarantees, do
not have the same disclosure or capital requirements as private sector
financial institutions, are growing like Topsy and have toothless
regulators. Oh and make extensive use of complex interest rate
derivatives (anyone remembering Orange County? but those were
*simple* interest rate derivatives). Remember how far the S&Ls had
their talons into the Senate? This smells like a big time financial
disaster in the making.
So what is the fallout for your typical individual investor?

If Fannie and Freddie get sick, how does the stock market overall
respond?

What does this mean for mortgage rates?

What does this mean for the availability of new mortgages?
 
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D

darkness

texsupport said:
So what is the fallout for your typical individual investor?
Right now, the stocks are probably quite cheap: PEs of sub 10 times,
for earnings quality that exceeds most banks.

But what we may be storing up here is a very long term, huge problem.

If Fannie and Freddie get sick, how does the stock market overall
respond?
Seen Japan lately? I mean, seriously: 1.6 trillion of debt default
would cripple the US financial system: it is about 15% of GDP (Japan's
banking problem is c. 25% of GDP).

But it is something that might come home to roost in 5,10,15 years.
In the late 70s/early 80s, the S&L crisis would have been resolved for
10,20 billion dollars. In the event by waiting until 1990, the cost
to the US taxpayer was $100bn plus, plus of course all the distorting
investments made in the 1980s which were effectively wasted capital.

If the GSEs were put on the same basis as other mortgage
securitisation entities like banks, now, in terms of capital,
disclosure and regulation, then the cost to the US might be mortgage
rates 0.1-0.2% higher. The cost of the GSEs going up in smoke in 10
years time could be many, many hundreds of billions.

Orange County was a spectacular demonstration of the problem of
derivative transactions by public entities, with minimal disclosure or
oversight.

When someone says something is 'too big to fail' (like the Japanese
banking system) what you are really saying is we are prepared to wait
until the crisis is of national proportions before doing something.
What does this mean for mortgage rates?
The implicit Federal government guarantee on Freddie/Fannie debt means
that in effect, mortgage rates are lower than they would otherwise be
(that is the taxpayer paying for that, because overall Federal
borrowing rates are higher.. actually the entire economy pays, because
of the distortion to the investment of capital).

The actual lowering of cost is probably on the order of 0.25-0.5% on
mortgage rates. The US has a highly efficient mortgage
securitisation system, so the need which created the GSEs in the
beginning (small local banks only) is no longer present.

Now if the system ever went into reverse, the entire US home lending
system could freeze. Work out the cost to the economy of say, 6
months of no home lending: the economy would shrink, and so there
would be more mortgage defaults and so on in a downward spiral...
What does this mean for the availability of new mortgages?
See above. In the short run nothing. But this is effectively a group
of companies that is operating outside the financial system, but have
a huge impact on it. They have neither the oversight of Congress, as,
say, the US military does, nor the oversight of market forces, as, say
Citicorp does (besides the oversight of the Federal Reserve). In that
sense, you might say they are outside the Constitution (stretching the
point ;-).
 

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