The ongoing housing bailout: taxpayers own 50% of all residential mortgages
The banking bailouts shouldered by the US taxpayer continue through the government loan guarantees keeping mortgage rates low to support bubble-era prices.
Many homeowners held out hope that if they could just keep current on their mortgage long enough, the government would come to their rescue in the form of a mandated bailout program. Part of this fantasy was not just that people could keep their homes, but that they could keep living their lifestyle as they did during the bubble. What few seemed to realize was any government bailout program would be designed to benefit the lenders by keeping borrowers in a perpetual state of indentured servitude.
The only group politicians really cared about helping were bankers. Do you think I’m being overly dramatic or cynical? Can you name all the bailouts to banks and government sponsored enterprises?
|Market-to-Market accounting change||It allowed to banks not document losses based on market value, until they foreclosed or sell the loan. Not a direct bailout, but it was a change designed specifically to help out banks during this bust.|
|$25 Billion Bank Settlement||It was meant to punish banks by ordering them to do $25 Billion of loan modifications. However, short sales were considered modifications, so losses they were going to take anyway counted as borrower aid. It was a sham.|
|TARP||This was a “loan” to banks to help return them to financial stability.|
|ZIRP (Zero Interest Rate Policy)||The Federal Reserve set interest rates at 0% to help stimulate economy; however banks benefit by not paying real interest on CD’s, and the low rates enabled buyers to bid prices back up to the peak to minimize bankers’ losses.|
|Freddie Mac & Fannie Mae Takeover||This kept Fannie and Freddie out of bankruptcy. In the long term it provided a conduit for the federal reserve to buy the bad mortgages off the bankers’ balance sheets through loan modifications sold to the federal reserve paid for with printed money.|
|FHA (subprime)||FHA was used to replace the private subprime lenders. It was used in conjunction with ZIRP to try and increase home values. The conforming loan limits were increased to help out the most bubble areas.|
|Tax Credit||The federal government wanted to stimulate home purchases by offering a tax credit. After the tax credit ended home sales dropped.|
|Quantitative Easing||This is a policy of the Federal Reserve to create money and then use it mortgage banked securities with the intent of pushing down mortgage rates to reduce borrowing costs and inflate house prices.|
|Fed loans to banks||Overnight .25% annual over night loans to banks to used for lending.|
|Hard Hit program||It is a tax supported principal write down if the lender agreed to for 50% of the write down|
The main problem with all of the plans is the moral hazard they created because those who did not participate in the bubble and behaved in a prudent manner were penalized at the expense of those who were careless with risk. In one form or another either through free market impacts or direct subsidies from the government paid by tax dollars, these bailout plans all asked the cautious to support the reckless.
So why did we bail out the banks? We could have wiped out all the equity and bond holders, recapitalized with taxpayer funds, then sold the public interest later. Sweden did this in the mid 90s, and it worked well. The only reason we did not do this is because the equity and bond holders like Goldman Sachs control our government and knew they could pass the losses off to us. The taxpayer is the bagholder, and the bag is enormous.
Mortgage lending levels are beginning to recover from the real estate crash of the Great Recession, but a large number of potential American home buyers are still being locked out of the mortgage market.
That’s because although you may be able to get a mortgage from your bank, few outside the government want to buy it. And that makes your bank less likely to write additional loans.
The answer to this dilemma is actually quite simple. To lure private capital to the mortgage market, interest rates must rise.
Everyone says they want private capital to form the basis of housing finance, but nobody is willing to accept the consequences of attracting this money: higher interest rates. The FHA and GSEs package mortgage-backed security pools, guarantee them, and sell them to investors. Without this government backing, investors would demand better returns, and the only way returns improve is if mortgage interest rates rise.
Of course, rising interest rates is the last thing lenders and housing bulls want to see. Higher interest rates would reduce mortgage balances, make housing even less affordable, and ultimately will either halt appreciation or cause prices to decline again.
… when private buyers, like investment banks and hedge funds, buy riskier loans that pay higher interest, known as private label securitization, the banks that originally sold the mortgages can continue lending to less-than-perfect borrowers. …
Now, nearly 10 years after the start of the collapse, the mortgage market is on more solid footing, with foreclosures down and lending up, but the private buyers of mortgages, such as hedge funds, bond funds and investment banks, are still wary from being burned in the last crash, so they’re buying less than 10% of the mortgages they did a decade ago.
As a result, government-sponsored enterprises have to buy up the majority of the loans to create liquidity in the market. According to the Housing Finance Policy Center of the Urban Institute in Washington, D.C., the private label securitization market was valued at $718 billion in 2007 and plunged to just $59 billion in 2008. It is valued at just above $64 billion today.
… the federal government is shouldering more than $5 trillion in mortgage risk out of a residential mortgage market of about $11 trillion, according to the Federal Reserve. That’s close to 50%, and up from 40% in 2007. By comparison, only 7% of residential loans were federally guaranteed in 1981, according to the New York Fed.
“Many investors don’t believe there is enough protection to make it worthwhile to invest in mortgage-backed securities,” David Stevens, the president of the Mortgage Bankers Association, the main Washington, D.C., lobbying group for the mortgage industry, said in an interview.
Protection? The issue isn’t protection. The problem is compensation for risk. There is no market for unsecured debt at such low rates of return. The only way private money is going to buy $5 trillion worth of mortgage debt without a government guarantee is if the price drops. Lower bond prices translate to higher interest rates.
The continued disinterest in private label mortgage backed securities in today’s environment is contributing to the slow recovery, he said, because banks are unwilling to write riskier loans that can’t be sold to Fannie Mae or Freddie Mac. ‘What that means is that the community bank that has a long relationship with perhaps a self-employed businessman who they know well, they can’t get him a loan, because nobody in the private markets wants to purchase that loan.”
The bank could make this loan and hold it on their balance sheet. Why don’t they? Because they want a better rate of return for the risk they take. It’s really that simple.
And Laurie Goodman, the director of the Housing Finance Policy Center, wrote in a blog post last week: “The loss of the PLS market could render mortgage securitization an exclusively government-sponsored activity and lock borrowers who need larger loans or have less than pristine credit out of lending.”
Bullshit. Higher risk borrowers can get loans now, but these loans are considerably more expensive to compensate for the risk.
Thus, banks that make these types of loans have but two choices: Keep the loans on their books (so-called portfolio lending), which increases risk for the bank if the loan goes bad, or find a private buyer who will trade the higher-risk of poorer quality loans for the higher interest rate payments, which even today can be as high as 7% or 8%.
So what has to be fixed? Goodman laid out some suggestions in a report last month, which included, among other things, better servicing standards, meaning that the investor knows when a loan is modified with a new rate or when delinquent payments are piling up.
Investors know exactly what they are being offered, and since they know it isn’t a good deal on a risk-adjusted return basis, they don’t buy it. Lower the price of the bonds (raise the interest rate), and the problem goes away.
And when it comes to buying mortgage-backed securities, investors should: Read. The. Fine. Print. “When investors bought a deal before the crisis, they read the deal summary but not the prospectus,” Goodman said.
They have read the fine print, and that’s why they aren’t buying subprime crap.
The bottom line is that mortgage interest rates must rise if private capital without government guarantees is going to be the basis of the market. Since the banks can’t afford substantially higher interest rates, I expect to see the GSEs continue in their current form, and I expect to see taxpayers continue bearing the risk indefinitely.