Fannie Mae, Freddie Mac's Role In The Perfect Real Estate Storm

[midwayer]

Fannie Mae, Freddie Mac's Role In The Perfect Real Estate Storm

http://realtytimes.com/rtapages/20040628_fanniefreddie.htm

"As for how bad it will get, my bet is on 30-percent declines in all the hot markets, i.e., both coasts and miscellaneous high-tech centers in the middle. This assumes that the Fannie and Freddie hedge funds don't bring down the entire system when the cycle goes into reverse. (As an economist, I cannot possibly see how Fannie and Freddie can be fully hedged when 1) they directly or indirectly guarantee more debt than the U.S. Treasury, 2) they are leveraged many times more than the commercial banks, and 3) the only conceivable counterparties for Fannie's and Freddie's derivatives (JP Morgan, Merrill, Citi, etc.) would logically be on the same side of the book as Fannie and Freddie.) If the systemic risk that Fannie and Freddie have created comes true, then I have no idea how bad housing will get.

"It would be catastrophic."

[xray s]

1. Now I know why Greenspan was shilling for variable rate mortgages

[Frodo]

3. Variable rate mortgages would make the problem worse.

Unless he expects deflation in the reletively short term as well as a decline in housing prices... in which case rates would come back down, but people could not refinance (because the house was no longer worth enough to act as collateral on the loan). The only people who would benefit would be those who had automatically adjusting mortgages.

Otherwise, if rates are going up for the near future, ARMs would increase the rate of defaults and worsen Fannie's problems.

2. Not just the bubble, but the "soap" which makes up the bubble is defective

Have you guys read the recent FDIC report on Fannie/Freddie MBS?

It says basically the MBS notes are all trading at a false premium--and that banks hold too many of them.

MBS notes underlie the whole mortgage mess.

The FDIC report never made the headline news.

So we float trillions in loans, and rising, in a housing "bubble"--but the "soap" which makes up the bubble (MBS notes) are defective, from a market standpoint.

That is, the bubble can suddenly contract without any external forces applied--interest rates don't even need to move. That's right, even the Fed has no control whatsoever over this.

I guess that is my biggest problem. The people in the know realize the notes are not really worth what they are trading at, yet they trade them anyway. That is inconsistent with a market economy, and will not work going forward, especially as the debts build.

Markets correct, as we know.

Dan

[Frodo]

4. There's a weakness in that theory. Demand

The demand for tech stocks went down sharply as the .com crash matured. That just exacerbates the problem.

As the population of the country increases, so does the absolute need for housing. Somebody has to own that housing (even if it isn't the person living there) and that involves a forced demand on the product - even if rates are rising. It will take an increase in rates far beyond the 2-3% expected over the next couple years to even drive home sales back down to the levels (high levels) they were at in the late 90's (say 5-5.5Mil/yr).

Now, that means limp price increases (1-3%/yr) and some super-hot markets like Northern Virginia possibly seeing some declines... perhaps as much as 10-15%. But that would impact remarkably few people - mostly those who had purchased homes very recently (since prices have gone up almost that much in the last year).

My parents had the same mortgage payment in 1980 that I have now on a house worth not quite three times as much. And if they had purchased it a year later it would have been far worse... but peope still bought those houses... because you have to live somewhere.

Regional mini-bubbles I buy. A nation-wide collapse? It IS the "worst case scenario", but the chances are pretty close to zero.

5. No no the fact that the MBS's are trading falsely is independent

Regardless of demand, the MBS notes are NOT trading at the market value.

But there appears to be a big hole--

Note, Moody's and S&P have not properly rated the MBS notes--either they are truly lower, OR the implied support of the US Treasury of the MBS notes would downgrade US Treasury bond ratings.

Either, or--not NEITHER (the notes have a larger debt than total US Treasury debt). In short, you cannot have 7 trillion(?) dollars worth of bond liability without affecting the rating of (any) supposed backers. This is a logical absurdity.

It looks to me like Moody's could be in line for being the next Arthur Anderson (of course, no one will say anything until after the collapse). That is, they claim implied support of one entity without accounting for the liability of the same on the assigned party.

But speaking of demand, their are plenty of vacant apartments...

You can satisfy supply and the demand quite nicely without bubbles.