IMF Issues Biggest Criticism Of US Policy To Date: Says Treasury Should Put GSE Obligations On Balance Sheet

Tyler Durden's picture

In another confounding episode of biting the biggest hand that feeds it, the IMF has just issued another criticism of US fiscal policy, and in its just released Global Financial Stability report says that the US should include in its budget the "cost of mortgage loan guarantees and other housing supports." Not only that but the fund also urges that the Treasury should immediately make its support for the GSEs explicit and carry Fannie and Freddie's roughly $7 trillion in debt (discussed extensively by Zero Hedge over a year ago: "Obama's Budget Has One Small, Missing Piece.... For $6.3 Trillion Dollars") on the books: a move that would send US debt to well over $20 trillion and make the ratio of marketable debt (the lowest common debt denominator) to GDP well over 100%. To wit: "Government guarantees should be explicit and fully accounted for on the government's balance sheet... There is a need for better-defined and more transparent government
participation in the housing market, with all such policies, including
strict affordable housing goals, transparently shown in the government's
budget." Of course this won't happen for many years as otherwise the US would effectively confirm that it is insolvent per various Reinhart-Rogoff ratios, and instead the administration will continue pushing with its misguided plan of offloading GSE obligations on the balance sheets of private institutions. As if that will change anything: it only means that the next taxpayer funded bailout will save the TBTFs once again, instead of leading to a run on the Treasury. End result: same thing.

Reuters summarizes the report:

The Obama administration has kept Fannie and Freddie off the budget, as did the Bush administration before it. Including them would make an already ugly fiscal picture look even worse.

The United States put those companies, which buy loans from banks and repackage them as securities for investors, into conservatorship in 2008 as the housing market bust led to massive losses on loans they guaranteed. The government has propped them up with more than $134 billion in taxpayer funds.

The U.S. Congressional Budget Office said in 2010 that Fannie and Freddie should be treated as government entities and counted in the budget, and many Republicans in Congress have pushed for that as well.

The IMF has generally tiptoed around direct confrontation on policy issues with the United States, which is its largest member and has effective veto power over any IMF decisions.

Overall, the Obama administration's housing reform proposals were "headed in the right direction, although some concerns and challenges remain," the IMF said.

The Fund said the reform efforts rightly focused on winding down Fannie and Freddie, adding the firms should be closed over the medium term to allow private-market securitization to return.

 The IMF also faulted the Obama administration for failing to address the tax deduction for mortgage interest, which it called "both expensive and regressive."

The tax break is hugely popular, and eliminating it would no doubt cause political pain at a time when the Obama administration is already preparing for the 2012 presidential election campaign.

Poor IMF: considering its recent Kotlikoff-assisted criticism of US budgeting proposals (see "IMF Says US Must Raise All Taxes, Cut All Entitlements By 35% To Contain Future Budget"), and now this, we anticipate some rather serious threats of funding withdrawal by the US, as nobody is allowed to even remind that Obama's head is planted firmly in the sand of denial (which according to recent reports is also radioactive, but well below soon to be hiked limits).

Quoting from the relevant section in the report:

The role of government in the housing market should be carefully reviewed as it may unintentionally contribute to financial instability. In particular, there is a need for well-calibrated government participation with less focus on direct provision of mortgage credit and more concern about systemic effects and externalities. Better calibrated government participation would also rely on more targeted measures to achieve social objectives, such as affordable housing for low-income households. Dedicated government agencies need to be transparent and carefully constructed. In addition, government guarantees should be explicit and priced upfront to mitigate the moral hazard problem—that is, lenders taking excessive risk based on the implicit assumption that the government will eventually rescue them in the event of a crisis.

A disproportionate focus on homeownership might exacerbate house price swings through government-led subsidization of mortgage loans and a relaxation of lending standards in response to growing competition between the government and financial firms. Some countries might want to reconsider their policies in this regard: for example, good-quality rental housing could be a better option for low-income households. A more level tax treatment across owner-occupied and rental housing would help reduce the current bias toward homeownership. In particular, in the absence of taxation of imputed rents and capital gains on housing, countries should reassess policy tools such as mortgage interest deductibility, which should be capped and apply only to first mortgages on primary residences.

In the foreseeable future, there seems to be a continued need for government guarantees for securitized mortgages, given the significant remaining uncertainty and vulnerability in the U.S. mortgage market, particularly in the private-label residential MBS market. Substantial swings in the cost of mortgage financing could be particularly damaging at a time when weaknesses in real estate markets continue to weigh on the economic recovery. However, government guarantees should be explicit and fully accounted for on the government’s balance sheet. Over the medium term, and with appropriate reforms to encourage “safe” securitization as discussed in the chapter, the GSEs should be wound down to make way for private-label securitization to reemerge as a viable option. Ultimately, the details of implementation will be key. The challenge will be to strike the right balance between delivering an appropriate level of explicit government participation and discouraging another cycle of overinvestment.

Bottom line: another one joins the ranks of the truth tellers... which can only mean the retaliation will be vicious.

IMF Chapter 3