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Fannie and Freddie – R.I.P. – what happens next?

The handwriting is on the wall. Fannie and Freddie failed as Government Sponsored Enterprises (GSEs) and are now wards of the State.  Talk about your socialism.  It seems that when push comes to shove and the only people willing to take mortgages off the hands of private lenders (banks,etc.) are Government bureaucrats, well, I guess that’s OK.

Unfortunately, even Congress — that bastion of liberalism and home of the bailout — is tiring of pouring good money after bad into the two mortgage giants that have been sucking up all the mortgages — good and bad — that private industry is willing to create.  To paraphrase one-time third party Presidential candidate, Ross Perot:  That giant sucking sound you hear is taxpayer money subsidizing home mortgages.

Now, the big questions remains: What will happen next?  If there is no Fannie and Freddie to buy up all the mortgages, who will do it?  Will the lenders who originate the mortgages be forced to keep them on their books and won’t this further inhibit an already tight credit market?

I’m not an economist and I’m not even a lowly retail mortgage originator.  However, my intuition tells me that as soon as Congress dismantles Fannie and Freddie or morph them into something unrecognizable, the housing market is going to go through a major radical shift that will make the current recessionary pressures seem like the “good old days”.

If there is no money to go around will it matter that real estate is totally automated, complete with fancy graphical transaction progress bars, digital signatures, and “showing agents” who will simply open a lockbox for you, wait outside and text their friends while you look around the house (oh,wait. that’s now.)

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Where will the money come from?  Where will it go?

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“Loves sunrise walks on the beach, quaint B & Bs, former Barbie® boyfriend..." Ken is a sole practitioner and Realtor Extraordinaire in the beautiful MD Suburbs of DC. When he's not spouting off on Agent Genius he holds court from his home office in Glenn Dale, MD or the office for RE/MAX Advantage Realty in Fulton, MD...and always on the MD Suburbs of DC Blog

41 Comments

41 Comments

  1. Ed Kohler

    August 8, 2010 at 9:15 am

    Hi Ken,

    Interesting perspectives. I’m no economist either, but I’m not letting that stop me from trying to figure out what the heck went wrong in the financial markets to lead to such a speculative bubble.

    As I understand it, the key to making the bubble grow was the market for offloading subprime mortgages as CDOs onto investors who should have known better. Goldman Sachs helped create the market and AIG was largely the buyer.

    Had an irrational market for offload utter crap mortgages not existed, the loans wouldn’t have been issued in the first place, which would have led to much less of a bubble, slower growth in home prices over the past decade (at a more rational level), and no need for the government to bail out financial firms that didn’t understand the financial risks involved in the investments they were making.

    I don’t think the government wanted to be in the mortgage business. However, they also didn’t want to see the real estate industry collapse even more than it had, so were in a bit of a no-win situation (while at the same time, being lobbied heavily for a bail-out by people who are normally free-market enthusiasts).

    As I see it, the housing market will return to one where people buy homes they can actually afford, with at least some money down. That’s what we’re seeing today. If you’re hoping for a return to a market where people don’t need money to buy homes, it will probably be 70 years before we forget the lessons we learned now.

    Regarding the political tone of your post, if you go to Opensecrets.org and look at the political contributions that were coming out of the finance industry at the time, I think you’ll find that they were pretty balanced. As I understand it, the top three things that motivate people working in finance are 1. Money, 2. Money, and 3. Money, so they tend to give to people with power on both sides of the aisle.

    • Ken Montville

      August 8, 2010 at 7:17 pm

      Hey, Ed

      Pretty good analysis. I agree that the housing market will most likely return to what it used to be pre-bubble. Unfortunately, I also think home values will return to pre-bubble levels leaving a lot of people underwater and “stuck” in their home with the inability to sell them.

      This, in turn, may help inventory which would normally help home values but in today’s amoral world, my thinking is that we’ll see lots of people walk away creating a long lasting foreclosure market.

      I don’t think the government wanted to be in the auto business, either, but sometimes you gotta do what you gotta do. Sometimes, I can’t help but make a dig at the hue and cry about socialism. Hardly a peep was heard when the government took over Fannie and Freddie. Of course, most of the American public probably think Fannie and Freddie is the name of a new sitcom.

      What bought this blog post on was some recent “Hill visits” I made with members of my State Association during the NAR Mid-Year meetings in DC. The Realtors making the visits were advocating for Fannie and Freddie. Most of the Senators and Representatives were non-plussed.

  2. Nadina Cole-Potter

    August 8, 2010 at 1:24 pm

    The repetitive comments above are exactly why I think so much of Twitter-type social networking is terminally superficial. Yes, it gets you distribution — exactly where, I don’t know. But it looks mindless to me. Wasted bandwidth.

    That being said: Fanny & Freddie. Either they will morph into some sort of hybrid with much more demanding (realistic?) underwriting standards and less risk to the taxpayer, or like Commercial Mortgage Backed Securities, residential mortgages will be securitized and sold either on private or public markets (as they probably are already). As it is, asset portfolios are already privately traded daily — between mega banks, from community banks to mega banks, insurance companies, etc., in every permutation you can imagine — and some you can’t. Heck, in a former life as a paralegal, I worked on deals where major bank trust departments (which managed both private and public bond issues) were buying and selling portfolio management contracts among each other.

    As for Fanny & Freddy being socialistic. Yes. It is corporate socialism which takes the private sector off the risk-management, prudent manager, fiduciary duty hook. For all his reputation as the apparent protector of the average citizen, Barney Frank sure has found myriad ways to get in bed with corporate America at taxpayers’ expense.

  3. BawldGuy

    August 9, 2010 at 11:56 am

    The race to socialism in real estate lending began when Carter got his way with the Community Reinvestment Act of 1977. He held banks hostage by blackmailing them with their FDIC insurance. The rest is history.

    • Al Lorenz

      August 9, 2010 at 12:45 pm

      Or, was it even earlier, when the mortgage interest deduction became law?

  4. Ken Montville

    August 9, 2010 at 1:26 pm

    As always, if anyone mentions anything remotely political, even in jest, the main point is entirely missed.

    What happens *post* Fannie and Freddie? Ed and Nadina answered it somewhat. I want to know how home mortgages will be affected when Fannie and Freddie are no longer around to buy up what lenders dole out.

    Any idea what the housing market will look like? Are we looking at a pre-Carter Administration housing market? What will that do for inventory? What will it do for home values? Foreclosure rates? The real estate profession? Will NAR contract to pre-Carter Administration membership numbers? Is that good? Bad? Indifferent?

    Maybe all this is better for another blog post.

  5. Brian Brady

    August 10, 2010 at 2:16 pm

    “If there is no Fannie and Freddie to buy up all the mortgages, who will do it?”

    Nobody will…or everyone will. I’m a “lowly retail mortgage originator” with some formal education (and lots of informal education) in economics so consider my opinion with that qualification.

    To use a BawldGuy axiom, lenders lend. Unfortunately, the government, through TARP and artificially subsidized mortgage rates, is creating a situation where lenders prefer arbitrage to lending. It doesn’t take a rocket scientist to borrow guaranteed money at 1% and lend it (with a guaranty) at 4.5%. This is the systemic problem that is distorting the market and arresting any chance of a recovery in lending.

    If the GSEs were allowed to fail, and FHA disappeared, lending would halt…for about 3-4 months. The recovery would be robust, sustainable, and at rates somewhere in the high 5s or lower 6s. Wall Street is taking chances on 5.75%-6% non-guaranteed, mortgage yields right now; there is interest in betting on the American homeowner. Low down payment loans would most likely be gone for about a year. As prices got stupendously cheap, niche lenders might offer lower down payment loans for 100 BP higher.

    You are right to criticize those who cry “Socialism” at the big government moves yet gladly lobby for subsidized residential real estate finance. The National Association of Realtors are a great example of that hypocrisy. It proclaims to be a bastion of the free market but asks for handouts.

    I, like some colleagues, think the GSEs and agencies have wrecked residential real estate finance. Why would I originate loans for them? It’s my job. If I didn’t seek the best possible rate for my customers, I’d be derelict in my duty and certainly out of business. Still, one can explain how the recovery of private mortgage banking will happen when this folly finally blows up.

    • Ken Montville

      August 10, 2010 at 2:37 pm

      Thanks, Brian. The most reasoned response, yet.

      • Brian Brady

        August 10, 2010 at 3:18 pm

        Thanks Ken. Let me answer the nagging questions in everyone’s mind: when and what?

        When?

        Probably not for another year or so. Even the party of “hell no” loves their housing subsidies and the party of “do it now” sees it as an opportunity to buy votes. We’ll find out about the latter on August 17 or 18. We’re really safe until 5-6 months into the New Congress. If the party of “hell no” successfully lets Fannie/Freddie die, and the FHA premiums rise yet again, liquidity will dry up. Call it sometime between May and September of next year.

        What then?

        Hand wringing, vociferous debate, name calling, and outright bribes to “restart” the GSEs. It won’t work. Meanwhile…YOU should keep your eyes on the small, regional banks. Moreover, keep your eyes on the regional mortgage bankers. Really sharp cookies will have access to private lenders (READ: HARD MONEY) Start developing relationships with these local banks today. When prices get to the point that all cash deals scooping up everything, those local banks will make 80-90% loans.

        Until then, save up your money for a 4-6 month stoppage. There will be a bonanza when the pent-up demand comes bac,k after Halloween of next year- you just have to survive for six months. This means you have 12 months to make 18 months worth of income- do it, be prepared, and profit immensely in the Fall of 2011. If you’re still around, you will have earned it

        • Ken Montville

          August 11, 2010 at 7:31 am

          I love bold predictions. Now that it’s on the Internet in and AG archives we can refer back to it at the end of 2011(not that I’ll remember).

          Regardless of whether your scenario plays out, the recommendation to squirrel away 6 months worth of money to survive on is rock solid.

          I kinda hope your predictions don’t play out exactly as described because my thinking is that, if it does, there will be so much political unrest it may lead to the type of rioting, etc. that we saw in the 1960s (not that anyone remembers that era) and the assassination of political leaders (also historical fact and *not, not, not* a call to action).

          • Brian Brady

            August 11, 2010 at 12:47 pm

            If I’m wrong it will be because they try to overhaul the agencies and rename them. Fannie, Freddie, Medicare, and Social Security are the most glaring of unsustainable government programs (the demographics screwed those pooches). The only response will be to monetize the debt or print more money.

            Then we’ll have another bubble. I think that will be in food and energy (which interestingly, are exempt from certain inflation indices). This means that the government will be “selling” a low interest rate environment while your grocery bill doubles and gas costs $8/gallon.

            Think seller-financing, Ken. I”ll be writing about that on BHB later this week

  6. Nadina Cole-Potter

    August 11, 2010 at 12:32 pm

    Does anyone remember the old days of private mortgage insurance? If you put less than 20% down, you paid PMI monthly until you reached 20% equity. Buyers hated it. PMI was not tax deductible like interest. So, what did the industry come up with? 10-10-80, 5-15-80 loans with the 2nd mortgage (at a pretty high fixed interest rate) substituting for PMI. These loans competed with FHA loans which required only 3% down and mortgage insurance paid up front by the borrower. I can’t remember, however, if the mortgage insurance was an actual out-of-pocket closing cost to the borrower or if it was rolled into the loan (Ugh!) When mortgage insurance was eliminated from conventional loans, it moved the risk from the borrower to the lender (and the MBS investors). That dumb sleight-of-hand, crazy low starter-rate ARMs that nobody understood, and “pick a payment” loans with negative amortization, contributed to the mortgage industry creating its own crisis, along with the production builders who overbuilt and sold to anyone who could fog a mirror (financing through their subsidiary or “preferred” mortgage companies). Add to that the bubble created by churning properties, complicit real estate brokers and appraisers, and investors over-paying and over-leveraging. It didn’t need Jimmy Carter, Fannie, Freddie or any government scheme to propel the mortgage industry and the real estate market into the dive it ultimately took.

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