Mel Watt on Fannie and Freddie - I want to go back to 2008

When Harry Reid (D-NV) changed the rules on how the Senate votes for a Presidential appointment, he opened the door for a critical change in the leadership at the Federal Housing Finance Authority (FHFA). In short order, the Administrations' pick for the job, Mel Watt, got the appointment that had been stalled for a year, and Ed DeMarco is out. Liberals hated DeMarco. And with good reason.

FHFA was formed when Fannie and Freddie went into receivership back in 2009. FHFA was tasked, by law, with one and only one mission:

Minimize losses to taxpayers from F/F

DeMarco succeeded in this mission. As of today, F/F have paid back virtually all of the bailout money they received in 2009 and 2010. By the end of 2014 the taxpayers will be in the black from the bailouts. How was this miracle achieved? Simple - F/F stopped making bad loans.

When I say 'bad loans' I mean mortgages that are not structured or priced right. A good mortgage loan is made to someone who has down-payment money and a job that pays enough to service the mortgage. The borrower must have a credit background that demonstrates that they are able and willing to make monthly payments. Not so complicated.

Mel Watt will take over the FHFA in January. But even before he finds where the bathroom is at his new job he is changing the rules. He stated on Friday that he wants to reduce fees to borrowers who do not have the 20% down-payment and for borrowers with lower credit scores.

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Watt's statement is payback for the liberals/progressives who want to take F/F back to the status quo of 2008 and who supported Watt to that end. In 2008 the mortgage giants were agents of federal policy on housing. The 'mission' was to increase home ownership at any cost. As it turned out, the cost of achieving those goals damn near destroyed the global economy. And now Mel Watt wants to turn the clock back five years and make the same mistakes all over.

What is the intent of the fees that were scheduled to go into effect in March of 2014? The goal was to increase the costs of borrowing from F/F in the hope that private lenders would come into the mortgage market and take business away from F/F. The DeMarco plan was to shrink F/F over time, and get D.C. out of the mortgage business. His actions were consistent with his mandate - minimize taxpayer risks. Demarco's words:

"those fees should rise in order to allow private investors, which target a higher rate of return, to compete."

So this frames the political debate. The liberal side of the equation wants to subsidize the mortgage market and exclude private capital. They want to do this to achieve social objectives of home ownership and to make a small step toward wealth redistribution. Lofty and admirable goals. But the tradeoff is that F/F will get bigger and more dominant in the mortgage business. Their role in the economy will expand, not contract - and the USA is once again opening the door for another crisis. A crisis that will work completely contrary to the stated goals of leveling the economic playing field (as it did in 2008).

With Watt taking over, the die is cast. FHFA, Fannie and Freddie are turning a corner and headed in a new (old) direction. When Watt takes over on January 6 we will see a bunch of new measures that will confirm the change in strategy. Many will cheer those efforts. It will mean a bigger role for F/F. It means the USA is doing a u-turn back to 2008. And it means that someday we will have a problem again.

Note:

It's not only liberals who hated DeMarco. Those who speculated in Fannie and Freddie common and preferred shares did too. DeMarco passed a rule (no votes anywhere) that 100% of F/F's income would go to the government and not be used to pay off the borrowings that occurred in the bailout. DeMarco's policy is now subject to suits from various hedge funds. DeMarco's action put the holders of F/F stock behind a huge wall. In theory, those shares are worthless, as F/F were on a glide path to be wound-down to nothing.

Watt can't deliver on his promises to those who got him his new job and at the same time continue with a plan to shutter F/F. If the companies do have a different future with Watt running the show, does that mean that the pref stock has a future too?

These are the actors on this stage:

The Speculators:

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