Sense on Cents

When losses get so large something ultimately must be done.

In that vein, I am not surprised to see news developing about Freddie Mac and Fannie Mae’s future. The Washington Post is reporting Administration Considers Splitting Fannie Mae, Freddie Mac:

The Obama administration launched a broad government effort this week to overhaul mortgage giants Fannie Mae and Freddie Mac and is considering splitting the companies and putting their troubled assets in a new federally backed corporation, administration officials said.

Troubled assets is a misnomer. ALL of their assets are troubled. Some are more troubled than others. How so? Freddie Mac and Fannie Mae absorb all of the credit risk on loans which they guarantee. Given the current state of our domestic housing market, the risk or troubled nature of every mortgage in our country, let alone in Freddie and Fannie’s portfolio, has increased. As loans continue to default at ever increasing rates Freddie and Fannie just bleed money. More troubled assets encompass a variety of commercial mortgages, Alt-A, and sub-prime mortgages.

I am very interested to see how a good bank/bad bank model would be structured. The fact is to wipe the slate clean, Uncle Sam would literally have to move ALL of Freddie’s and Fannie’s current assets. At that point, Freddie and Fannie should simply guarantee future mortgages without actually purchasing them (meaning let the mortgage securities be purchased by private entities in the marketplace) with proper risk based pricing applied. Short of that, a restructured Freddie and Fannie will likely only replicate a version of past errors.

Do our regulators have the courage to push for this initiative? We will hear that they will work toward this structure ‘down the road.’ How long is the road? This situation will be very interesting. Will it be transparent?

Such an approach would keep the government on the hook for losses into the indeterminate future but would also clear the way for the revamped companies to play a critical role of financing home loans throughout the country.

This statement is nothing short of an acceptance of a ‘socialized housing program’ to absorb current and future losses but also to underwrite future loans at what will effectively be below market rates. The fact is losses will be perpetuated simply because Freddie and Fannie will continue to subsidize mortgages via lower mortgage rates. In the process, risk is being mispriced under the guise of supporting our housing market. Increased risk will ultimately mean increased losses.   (more…)