D.C. & Mortgages

Bruce Krasting's picture

Two seemingly unrelated developments in the nations mortgage mess this
past week. They both point to how difficult it will be to bring some
stability back to the system. I am wondering if they are connected.

The first came as a surprise to me. Mr. Joseph Smith was supposed to be
confirmed as the Director of the Federal Housing Finance Authority.
Smith was a state banking commissioner from North Carolina. He was a
White House pick. Up until last week I thought he was a shoe-in for the
job. Kaboom.

Smith is out. Nixed at the last minute by none other than Richard Shelby
(R. AL). The ranking member of Banking, Housing and Urban Affairs waved
his arms and sent Smith back to North Carolina. Senator Shelby had this
to say:

Shelby's main concern was that Smith would be a “lapdog” to outside pressure to use the GSEs, at taxpayer expense, as vehicles for large-scale homeowner assistance programs.

Lapdog? Maybe, I don’t really know. But I doubt that is the reason for
canning Mr. Smith. This is politics. Senator Shelby wants his own guy
running things over at the FHFA. It is much easier to steer the outcome
that way. The early talk is that Mr. Smith is going to be re-nominated. I
doubt it. Come Jan. 1 there is a new set of voters on this. If Shelby
is saying "no" in December; the majority will say no in January.

We need a very strong hand in this position. 2011 will be the year that
Fannie Mae/Freddie Mac get put on the operating table and decisions will
be made what role these two dogs will have for the next decade or so.
Needless to say this is a critical step if we are to have an outcome
that moves us away from socialized mortgage finance. At this point the
D.C. lenders are 95+% of the new mortgage market. One way or the other
that number is coming down. How our dependency on Washington for the
loot that keeps the real estate market alive is resolved will be make or
break for the entire economy.

Normally I would say the side show political fight over this appointment
was just normal D.C. fun and games. Not the case this time. Keep an eye
on this fight, it will provide clues on the direction this is headed.

I have seen again and again where a study by the Congressional Budget
Office later becomes the basis for legislation. The CBO put out a report
on 12/23 that dealt with Fannie and Freddie. The paper is long and does
not contain much new information. The following is the cover page. I
thought it sends a terrible message. When I look at it all I can think
is, “The Federal Government is lending against every one  of these homes!” Not the image they should be going for.

The CBO tries to layout all sides of the argument on this critical
issue. They are quick to point out that an extreme outcome is
undesirable. We can’t continue with the government providing nearly 100%
of all mortgages, and we can’t expect that the government’s role will
fall to a small number anytime soon. The CBO conclusion is that we have
to move toward the middle. They call it a Hybrid Market.

I think the CBO is right. While I would love to have Washington’s role
in the mortgage market eliminated altogether, that is just a pipe dream.
If we shut Fannie and Freddie down on new lending the economy would
tailspin into chaos.

The CBO did have one recommendation that I thought could be very useful. They want the government to recognize UP FRONT a mark to market cost of providing a mortgage. This cost would go on the budget as a current expense.
The Administration and Congress would fight over all aspects of the
budget (as usual) but if they had an agenda for housing
(stimulus/support) they would have to appropriate the money and vote on it where all could see the results.

The concept is relatively simple. Assume that the private market for a
30-year mortgage was 6% for a “good” borrower who has 20% equity down

Now assume that in its wisdom Washington wants to provide a stimulus to
the housing market. Fannie and Freddie are willing to provide the same
30-year mortgage at 5% and they are will to do it for a lower rated
borrower and they are willing to do it at 90% of the purchase price.

Clearly this is a subsidy that will ripple through the system. The
suggestion by the CBO is that government would record a charge UP FRONT
equal to the difference between the actual terms of the loan and the
market terms for the same financing. As the F/F loans have a high
advance rate they would get a higher return than the 80/20 deal. If the
market rate for the 90/10 deal was 7% then the cost to the government
would be the Net Present Value of the 2% over the life of the loan
(average 15 years). In this case the government would have to recognize
a current cost of ~$15 for every $100 they lend.

My example might be a tad extreme. The point of the mark to market is to
force Washington into recognizing that there is a cost to their
lending. For years we went by thinking that all that cheap money was in
fact without a cost. 2007-10 proved how wrong that was. Fannie and
Freddie will cost the taxpayers more than a half trillion before this is
all done.

Nothing will move Washington out of the lending business faster than if
they have to pay for it. Recent history shows beyond doubt that there
are real costs to subsidized mortgage lending. For the current budget to
take a hit that approximates the fair value of mortgages would be the
smartest thing we could do. The reserves created would go a long way
toward assuring that there would never be a blowup and conservatorship
again. If the reserves prove unnecessary after a period of time they
could be returned to the taxpayers as a bonus. From the CBO report:

believes that treating Fannie Mae and Freddie Mac as governmental
entities for the purposes of the federal budget, and accounting for them
on a fair- value basis, accurately reflects their current status. That
treatment also provides more timely and relevant information to
policymakers considering options for the future of the GSEs.

For instance, if legislation required Fannie Mae and Freddie Mac to
increase subsidies on guarantees to first-time home buyers through a new
program, the program would show an immediate cost under CBO’s budgetary treatment.

If you’re a conservative and you want to see a smaller role for
government the CBO proposal on mortgages is the ticket for you. I can’t
help but connect the dots between Shelby’s "no" vote on Thursday and the
CBO report from the same day.

Something along the lines described by the CBO is coming. Barney Frank
does not have the influence or the votes to stop it. Strong hands like
Shelby will get their way. While the actual outcome is cloudy there is
one conclusion you can take to the bank. Mortgages are going to be more difficult to get and they will cost more in twelve months. That will hurt, but it is a good thing.

Note: Edward DeMarco is the acting director at the
FHFA. He has had this ‘temporary’ position for two years. Ed has done a
good job. I believe that his policies and actions have consistently
taken the side of the taxpayer. Exactly how it should be. DeMarco
deserves a shot at the job. I doubt he will get it. Another mistake.

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huckman's picture

Denninger has a great update today on the REMIC trustees.

Panafrican Funktron Robot's picture

Too many entities make their living on the government guarantee backstop of the GSE's.  Even a partial removal or qualification of that backstop will completely fuck up everything.  As Richard Shelby is a puppet for said entities, I'm sure Mr. Smith was probably just the wrong kind of lapdog.  I repeat, there is no way in hell they're removing that guarantee backstop.  They will defend that backing at all costs.  There is literally about 3.25 trillion dollars wrapped up in that guarantee.  Anyone still think housing is small potatoes for the economy?

Common_Cents22's picture

How many billions were stolen from retirees and savers by ZIRP?

Common_Cents22's picture

How many billions were stolen from retirees and savers by ZIRP?

Astute Investor's picture

According to David Stockman, ZIRP has cost American savers approximately $250 billion.

DR's picture

Without the GSEs only the TBTF "private" banks would be making mortgages. Either way the government is going to back stop the market.

Astute Investor's picture

Any "asset" that requires ZIRP as well as artificially low interest rates in order to maintain a perceived market value is by definition worth far less.  It's really nothing more than a form of price controls.  We know how that worked out back in '70s.

Let the market clear and we can all move onward and upward.

snowball777's picture

We are fully prepared to make every one of Nixon's mistakes over again, if called to serve.

What's next in the flashback sequence...an OPEC embargo?


hedgeless_horseman's picture

What's next in the flashback sequence...an OPEC embargo?

My bet?  The mother-of-all-yield rallies.

Salinger's picture

How our dependency on Washington for the loot that keeps the real estate market alive is resolved will be make or break for the entire economy.

On two separate occasions I have heard pundits on Bloomberg downplay the role of housing in the economy with the statement that housing  accounts for just 5% of GDP. One was Larry Kantor of Barclays who made that comment on Dec 16.

Bruce Krasting's picture

Long ago and way back when I worked with Larry. He was as wrong as the next guy.

If these suits really-really knew the future you think they would tell you on TV?

Mohammad said, "You cannot foretell the future". Neither can Larry.

Temporalist's picture

And conversely when housing is doing great they claim how important it is to the economy and how it is a measuring stick to its strength.

I guess the derivatives and housing sector equities are minimal too and tax revenues are a trifle as well as energy and construction and materials and....

Just piddling because the middle class is meaningless to the kleptocracy.

hamurobby's picture

I think you hit the nail. There is no way they WILL let housing find a true value, the value will not sustain enough tax base to pay the promised retirements and wages for government. We will get our inflation because the system needs it, middle class be damned.

When I hear the talk that change is coming in the beltway, all I can envision is those new idealistic elected getting herded into a room and explained to them how if the current system isnt extended, they will loose their money, power and be blamed for the collapse. Only a very few (like Ron Paul) are actually ready for such a scenario and are willing to bring about the change that is needed. Its just not going to happen until it cant be extended and pretended any longer.

doolittlegeorge's picture

what's this girl got to do with DUI's btw?

doolittlegeorge's picture

obviously wrong to look at the housing market "as one housing market." Florida and the West Coast can clearly recover as "the ranks of billionaires might be thinning" the "ranks of middle class foreigners" is not. interesting to say the least that "the Federal Government itself is the sole loan originator in the biggest mortgage market on earth."  talk about risk aversion!  "fear of failure kills a market, too" thus the Federal Government "propping up THIS market" of all things is a made to order fiasco and so long as it continues "serves only to drive the price of that which is very valuable lower and lower and lower and lower."  I find "a shooting war between the US and China on the Korean Penninsula" a potential "out" as they say.

Temporalist's picture

So you believe foreign investors weren't part of the current housing bubble?  In Florida there were so many South Americans, Europeans and Canadians buying property it looked like a completely different country.  In California Chinese, Japanese, Koreans, Central and South Americans flooded that market too.

Maybe they won't take losses because they will run back to their home countries and just walk out on their underwater mortgages.

banksterhater's picture

There's going to be a logjam of close to 8 mil foreclosures in the next few yrs, how can that not be Chinese water torture to the economy? There's no balls in Wash for a RTC-type thing.

honestann's picture

NO.  No more half-way measures.

Get government 100% out of the mortgage biz.

What will happen is obvious, and is what should happen.  Home prices will crash... which is the current terminology for "return to slightly below the long term average".  In other words, home prices would fall to about 50% above the appropriate price, but 20% below the long term averages.

People don't realize it, but home prices have been driven far, far, far above their natural and appropriate levels by decades and decades of government perversions of this market, and massive abuse of "fractional reserve banking".  This is the single biggest reason that today, average people are vastly further in debt than ever before, even though BOTH parents are working, and massive new productive efficiencies have been realized since cheap computerization and automation became a reality.

Get government totally OUT of the mortgage market.  Let the chips fall where they may.  Let home owners walk away from their mortgages, and let the banks take back the homes that they freely accepted as collateral for those homes.  Let the banks fail.  Shut them down.

Let home prices fall to where they belong (where ever they naturally go), whether that is 30%, 50% or 65% below current prices.

That will start a BOOM in the housing market.  Furthermore, since people will be buying homes that are FAR less expensive, they will have LOTs of extra income left over to buy other products without going into debt... thereby spurring the rest of the economy in a major, but natural, sustainable way.

Government.  Get the hell out of "business".

snowball777's picture

Woohoo...let's make sure we have a 100% secondary mort market bailout next time!

OPM is OPM whether it comes from a taxpayer or MBS bought by some schmuck's 401k stash and will continue to blow asset price bubbles with or without GSEs through the secondary mort market; there'll just be more 'jumbo' loans on the books instead of conforming ones when the SHTF.

Eliminate the mort interest deduction...why encourage yuppies to borrow even more on ARMs and forego the revenue to afford defending their McMans?


hardcleareye's picture

The very large powerful corporations have "carte blanche" and the mid to small businesses are "regulated and taxed to death".  This is no accident......

When you say "get the government out of the mortgage market" are you also calling for no government regulations of the mortgage market? 


snowball777's picture

Of course HA is...until a contract goes haywire and then it will be all about sparing no expense to defend Ann's property rights.

Hey Ann, what "government intervention" is most responsible for the mortgage/foreclosure fraud?

(hint: it was an executive order to the OCC by a famous chimp circa 2003)

honestann's picture

If I ever buy a home, it will be with cash.  Though I do have enough saved now (about $300K), I won't be buying anything in the USSA.  I'm leaving in 4 months, never to return.

Anyone who imagines, in their wildest dreams, that government gives a rat's ass about helping you in any way (resolve contract issues), has been smoking crack or something worse for far, far too long.

Answer to your question: Probably the GSAs layered on top of "fractional reserve banking".


RockyRacoon's picture

Sorry to say it won't happen due to the special interests involved.  Good sentiment on your part, however.  There are too many cooks in this kitchen, some of whom we'll never hear of.  There is more than one Wizard behind that curtain, unfortunately.

RalfMalf's picture

While it may not happen due to special interests involved, it doesn't mean I am required to participate!

I never owned real estate. 

This year (2010) I bid on one REO and lost out, bid on a short sale at 1/2 of assessed value....and pulled the offer while I still was able.

I've convinced the wife that renting is the way to go.  I'll not join the ranks of middle (or upper middle) class slaves. 

I'll not sentence myself to running in the corporate wheel like a hamster on coke, worrying all the while that hopefully they don't find someone younger, cheaper and smarter (they will) and replace me when I'm most vulnerable.


I'll still bust my butt at the office, but I'll be a renter from here on out. 

I'll pay up to live in a nice community and keep my kids in a great school system.  But I also won't take the inevitable beating that will be required by municipalities of their resi real estate owners.




Panafrican Funktron Robot's picture

Guess who they're going to pass that beating onto? 


Mr.Kowalski's picture

ebworthen: "They will either confiscate or put withdrawl limits on IRA's and 401K's, essentially trapping money in the markets and use that to fund the next speculative debt bubble"

The INSTANT this happens, electronic withdrawls by large foreign interests will commence, ensuring the collapse of the entire banking system. Think I'm joking ? Take a gander at this CSPAN video about what nearly happened in 2008:http://www.youtube.com/watch?v=m_atOvrTtT8&feature=related 

Dburn's picture

Thanks for the link. One has to wonder if "the collapse of the banking system and the political system as we know it (my emphasis)" is something that was just delayed and would it all have been bad had it happened all at once or collapsing  by thousands of cuts each month and year until both end results would have been the same only after years people don't have the energy to rebuild or the trust. I also have to wonder if "the collapse of the politcal sysetem as we know it" may have been the catalyst needed to get rid of the "Buy the govt you want, not the govt people need".

Mr.Kowalski's picture

Wow Bruce.. and here I was thinking my view of "After the Crash" was grim.. your view of the dark side is far worse than my scenario:


But I agree with the concept Bruce.. I think few people recognize just how bad a collapse could really be. 


moneymutt's picture


First, I must say you are wicked smart, well-informed and seem exceptionally rational as opposed to rigidly partisan...don't see that much these days, but of course ZH is one of few places one would expect commentary like yours.

I'm a littel skeptical on the Shelby thing in that I have not seen any more ideologicaly pure commitment to ideals from Repubs than I have seen from Dems. And even if he had courage and ability to get what he wanted for Fan and Fred, there are very powerful interests against him. Home builders, realtors, bankers, Fan/Fred bondholders etc..

I agree with you that just pulling the plug is uneccessarily harsh solution. I think there are plently of examples how to do an orderly unwinding, I believe that is the whole idea of bankruptcy protection, FDIC method of shutting down banks etc.

Fan/Fred bondholders should have been wiped out. Fan/Fred should have been handled more like GM. I heard even fairly conservative business analysts say the temp govt ownership of GM was more business-like than the previous management (not that is a high standard). The businesses infrastructure was not unneccesarily trashed, it was kept intact, a net good for US.

Someone really smart can probably tell us what the right mix is between all cash deals for housing and having mortgages, and how involved the govt should be. I think we can all agree it is something less than 95 percent.

What seems absolutely silly to me is creating a giant private enterprise that the govt has to back simply to lower the interest rate 0.5-1.0 pts on mortages compared to private mortgage market. Shoot, the Fed can lower rates for free, no?


apberusdisvet's picture


We are no where near the bottom of housing and that is why the potential liabilities of F&F are vastly understated.  More likely in the trillions.  But it's only more worthless paper not to worry about.  Right?  Some estimates place our total debt liabilities north of $200T, including all those conveniently placed off balance sheet.  There is no way that this debt can be repaid, by any combination of circumstances except outright default.  Zimbabwe or Weimar hyperinflation  would totally destroy this country even for the vultures that await.

My personal feeling is that the banking cartel is shit scared right now.  It envisioned an incremental end game, one that they could manage.  Events, however, have gone beyond the bankers control.  2011 should be interesting to see how much further down the road the can will be kicked.

goodrich4bk's picture

Bruce, I read your 09 parade of horribles.  I don't buy it.  Installment credit has been declining for two years which means Americans have not been incurring any NEW credit.  In other words, the availability of new credit is NOT required to keep Americans spending.   They are spending without incurring a single dime of new credit.

The real nightmare scenario is a nightmare for bankers and their bondholders.  And that is this: Americans only need to pay their existing credit balances IF they are granted continuing credit.  So the nightmare you imagine would more likely look like this:


1.  Credit freezes.

2.  Consumers unable to get new revolving credit stop paying their existing balances becausethey need the money to fund cash purchases.

3.  Bank bondholders who finance all existing consumer credit would suffer massive losses as their bonds plunged in price.

4.  Margin calls would accelerate and exacerbate the bond losses.

5.  Retailers would replace credit with layaway and inhouse credit programs.

6.  Most of the above losses would be felt by foreign bondholders, not average Americans.  In other words, most of the losses would be taken by those who voluntarily agreed to take them and who have been paid to accept them (in the form of interest returns greater than treasuries on such bonds).

7.  The creation of local credit unions and banks to replace the VISA/MC system of securitized lending would decimate Wall Street firms that earn fees from the trans-national system of securitized finance.



ghostfaceinvestah's picture

"They are spending without incurring a single dime of new credit."

The government is doing the borrowing for them.

Record deficits --> stimulus+transfer payments+squatter stimulus+etc -->sustained consumer spending.

Trust me, your share of the national debt has risen through no choice of your own.

max2205's picture

Mortgage market is still barely breathing

Temporalist's picture
Home Prices Probably Fell, Baring Weak Link in Accelerating U.S. Recovery


Problem Is's picture

Nice summary of the CBO report, Bruce. Thanks for the facts and info.

King comb-over with a lap-dog brown dye job... Clown party R and Clown Party D both do exactly what TBTF tells them to do...

If anything it is competing sides of Wall Street racing the bitch Congressional ponies they own, not competing sides of a phony political left/right paradigm...

Kayman's picture

Problem Is

I couldn't agree more.

Watching our politicians is like watching Wrestling.  Entirely choreographed and you get an extra large brown envelope on Sunday if you bleed on the matt.

gwar5's picture

Kill the big zombie banks with their toxic assets, break up the rest of the TBTF like Volcker suggested to create a market, and then get rid of Fannie and Freddie and all the criminal cronies there, too. The world will survive without the Prince Alaweeds, Robert Rubins, and Citigroups.

Kayman's picture

I don't know Bruce ? Do you think this will pass the Central Planning Committee's 5 year plan ?

Will there be room for the skim for the parasites ?

Cobbling together a "free" market by political whores and the bankster parasites requires putting the common good first.

And at that point it will die.

Bruce Krasting's picture


Read my lips:

I would love to have Washington’s role in the mortgage market eliminated altogether

That aint happening. So what's a reasonable plan B? Are you so sure you want to cross to the dark side? Tell me what it might look like?

I wrote the following in February of 09. That was a scary period. I tried to describe what it might look like. These things will not happen. We came close back then. We are not out of the woods, but the worst case is avoidable.


Capitalist10's picture

How about requiring mortgage lenders to keep 10-20% of the loans they originate and absorb the first 10-20% of any losses.  That would get rid of a lot of the social engineering in home lending.

A Nanny Moose's picture

Ain't happenin'? Really?


Our current path is toying with currency destruction. The middle class will feel it first. At which point cross over to the dark side anyway.

A large swath of the population losing money based on bad bets, is always preferrable to an entire nation with no purchasing power. In the former, those with capital can make a new start, ad help those in need. In the latter, nobody can help anybody, because capital does not pool, and if it did, it would buy nothing.

ebworthen's picture

There is no plan B, they don't want a plan B, or C, or D.

What we have is exactly what was engineered; a decade of commissions and profits from the origination, payments for a time, loans bundled into CDS's, and when the profit of the venture had been milked the dead cow was handed off to the current and future taxpayer.

Privatized gains with socialized losses.

This is the same model as healthcare.

If they can't let the TBTF banks fail, or the car makers, or the AIG's of the world; why would they ever let the government (taxpayer) backed milking cow of a mortgage industry fail?

They won't.

They will either confiscate or put withdrawl limits on IRA's and 401K's, essentially trapping money in the markets and use that to fund the next speculative debt bubble.

Kick the can, kick the can, kick the can.

The word "confiscate" won't be in the bill of course, it will be a euphamism such as "American Home Security Act" or some other invention of sophistic sausage these harpies and warlocks dream up under the dome of Oz.

Thoreau's picture

"...the worst case is avoidable." The worst case is unknown. And if I understand you correctly, you are suggesting continued obfuscation and controlled demolition of an inevitable correction. If that's our best plan... well, we have no relevant plan.

And what's so "scary" about transparency? Because that's really what we're talking about here. Truth, trust, public opinion, a return to the mean, castration of soaring deficits, the war machine, overindulgence, etc, etc. Let's take some freakin' medicine for a change!

Kayman's picture


Took the time to read your Feb 09 thoughts.

1. Saving the New York Fed banking cartel has cost us the economy. They should have been put into receivership and broken up. If the same money was placed with banks that function as financial intermediaries the economy might have had a chance.  The seeds have been planted for a garden of weeds for at least another decade.

2. Housing has become affordable in most of the U.S. It is only the "money for nothing" policy of Greenspan/Bernanke that created the distortions (via inflation) in the first place. Countless stories of families broken up because of these ZIRP and near ZIRP policies whose only real purpose is to fund their puppet masters.

3. Without a revival of American manufacturing, with the attendant creation of well-paying jobs, we are going to suffer high inflation along with high unemployment.

All the chaos, fear and wealth destruction brought on in the fall of 2008, rests at the feet of the very people that are currently doing the very same deeds that got us into this mess in the first place.  Moral Hazard indeed !

Tell me Bruce- what is your estimate of the "unrecorded/undisclosed" losses hidden at the Fed and the big banks ? 

And isn't it true that all the funding from the Fed and Treasury is simply supporting yesterdays horrific losses and not going to the productive economy ?