The Paulson Gamble
If we are to believe the mythology, Secretary Henry Paulson was sometimes called Hurricane Hank in his days at Goldman Sachs; a hard driving pragmatist who jumped head first into complicated problems, came up with elegant solutions, and pushed his subordinates into action. He was also thought to be a free market faithful. All of this of course, was before Fannie and Freddie became technically insolvent. But now, after engineering a massive bailout plan for the mortgage giants, it is much more likely his nickname will be ‘The Socialism Secretary.’
In his defense, no other reasonable options were left. After decades of fiscal policy failures and monetary policy failures, the credit crisis of 2008 was a fait accompli. But what does all the wrangling aver Fannie and Freddie really mean to our clients?
Interest Rates
Remaining stubbornly high these days. Maybe some short relief in sight, but heading even higher in the future.
If Fannie and Freddie can borrow money cheaply, they can loan money cheaply. Paulson’s plan was supposed to ease the rising borrowing costs for the giants, but it ended up having quite the opposite effect. Why? Everyone is waiting for Paulson to drop his other shoe.
Gaining authority to bailout Fannie and Freddie was supposed to calm jittery markets. Paulson was trying to say ‘hey, I won’t let them fail. They will be here for you and for the housing market. Don’t worry.’ But if the Treasury and the Federal Reserve were to go through with a bail out, it would most likely wipe out existing shareholders and maybe some bondholders. So it should surprise no one that shareholders and bondholders are not crazy about their future prospects. In other words, Fannie and Freddie are still paying more to fund themselves.
What’s worse, since their existing portfolio is getting more expensive to maintain, they need to make as much money as they can on new mortgages they buy or back. Of course 30 year fixed rates typically follow the movement of the 10 year treasury. In recent weeks, the 10 year has been doing just fine. But because Fannie and Freddie are having to pay more for their money, and because they are needing to make more money these days to make up for their massive losses, 30 year fixed rates are way above where they should be based on looking at the 10 year.
Now, it is possible, even likely, that when Paulson and company ride in to save the day, the spreads on rates will shrink and we all may see some relief when it comes to interest rates. However, much deeper market fundamentals will soon overwhelm that temporary relief.
Property Values
Values will continue to fall nationwide through at least the end of 2009 or beginning of 2010. Some areas will stabilize before then. Some will see a dead cat bounce as pent up inventory floods the market at the first sign of an up tick.
All the players are gone. We may all hate the letters CDO, but their demise left a gaping hole in the market. Retail mortgage outfits can not make mortgage loans outside Fannie, Freddie and FHA, because no one is left who will buy them. No one is buying those mortgage loans because no one is securitizing them. No one is securitizing them because no one will buy the resulting securities. No one will insure them. No one will even touch the existing ones. 9 of every 10 loans made these days are basically thanks to the government. Property values continue to fall, but at least there is some mortgage money left to allow transactions to take place.
We all know that property values are hurt by foreclosures. But they are also hurt by the absence of mortgage financing. Mortgages for second homes are getting tougher, mortgages for investment properties are getting tougher, mortgages for condos are getting tougher. Fannie and Freddie (and of course the true government lending of FHA and VA) know they are the only game in town. They are trying to reign in their lending, tighten their standards, husband their resources, prove to investors they are worth it. If you were the very last restaurant in the city after a storm, three things would probably happen. First, you would charge a little more. Second, you would be more concerned with core functions of the restaurant and less concerned with garnishes on the plates. And third, you would go into a bunker mentality, waiting for a return to normalcy. Well, Fannie and Freddie are the restaurant and we have to eat what they serve.
Property values will be held down by this lack of mortgage financing. No way around it.
So what do we think?
Our tune is the same. Fannie and Freddie are too large. They have slathered Congress with money for so long they are all covered in the stench of cronyism. Beyond money, Fannie and Freddie are like retirement homes for Washington insiders who need an ATM in their golden years.
Their central problem is, and always has been, their profit is privatized and their risk is socialized. The only time anyone could ever smack them around long enough to put them on a plan towards gradual diminution and eventual privatization would be in a time of extraordinary crisis. Hmmm, I wonder when a crisis might come along that would present the possibility of fixing our national folly once and for all? Almost forgot, we squandered it last month when most of our Congress agreed that Socialism is better than Capitalism. Political pandering is so beautiful.
In any event, Paulson’s hand in this mess has been forced. His rescue plan to shore up confidence in Fannie and Freddie has backfired and actually served to erode confidence. His only option is to get through both political conventions and announce a significant rescue plan before the market pain deepens. As with his previous plan, the announcement will probably be timed on a Sunday prior to the opening of the Asian markets.”
