Two weeks ago, the FHFA, using Moody's assumptions and modelling, said that a worst case scenario for Fannie and Freddie could result in total costs to taxpayers of $363 billion, an incremental $220 billion to the $148 billion already spent to keep the nationalized housing branch of the US government. Today, S&P has released a stunner which says that actually fixing the GSEs, and "resolving and relaunching" the bankrupt entities, would actually cost as much as $685 billion, or over another half a trillion in taxpayer costs. And as for the reason why the market is surging, and will be until the US annexes Zimbabwe, now that it is pricing in QE 7, S&P says that according to its estimates, the backlog of shadow inventory is 40 months! Tomorrow: another trillion dollar capital defficiency hole, uncovered somewhere in the ponzi that is the US economy, will cause QE 8 to be priced in. And so on.
As Standard & Poor's Ratings Services sees it, the problems in the U.S. housing market are far from over. Moreover, with a growing portfolio of unsold homes, a sluggish economy, stubbornly high unemployment, the prospect of rising foreclosures, and billions in legacy losses, it appears unlikely in our view that housing and mortgage markets will be able to operate normally without continuing and substantial government involvement. That will likely mean further taxpayer support for Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs) that, along with the Federal Housing Administration, now buy more than 90% of all home loans compared to less than half before the crisis.
That support has so far come at a price, which we believe is likely to rise substantially. Standard & Poor's estimates that the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the $148 billion already invested--money largely spent to make good on loans gone bad. (Both GSEs are already in receivership.) That $280 billion, however, could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize. Although federal authorities have taken no concrete public steps toward sponsoring a GSE alternative, , Standard & Poor's believes that it's a useful exercise to consider how much such a recapitalization might cost taxpayers.
Our assumption is that it could cost an additional $400 billion to establish a new mortgage intermediary, capitalized at 7% of total assets -- although a smaller entity could be formed and capitalized based on risk-weighted assets. That $400 billion would, in our estimation, be enough to cover all losses and to support new business. We illustrate this cost at the 7% level. We are not aware that the regulators are targeting any specific capital levels. However, in the wake of the financial crisis, we believe more capital than may previously have been necessary will likely be warranted--especially if the government transfers ownership of this new institution to the private sector. If the government retained ownership, however, we estimate that the surviving entity could be capitalized as low as 4% of total assets, or about $225 billion. The taxpayers could bear the recapitalization for a purely government-owned entity, although private owners (e.g., financial institutions) could also capitalize it cooperatively.
In coming up with these estimates, we have also assumed that the future earnings capacity of such an entity can support provision and reserve levels for further originations. We did not, however, impute future dividends since we didn't project operating earnings or losses to make our estimates specifically comparable with those that the Federal Housing Finance Agency (FHFA; the primary regulator of the GSEs) recently released.
On Oct. 21, 2010, the FHFA projected that total Treasury draws by Fannie and Freddie could total $142 billion to $259 billion, excluding preferred dividend stock payments. The FHFA bases its approach roughly on the approach that the federal banking agencies took last year in the Supervisory Capital Assessment Program, which produced potential rather than expected outcomes.
However, we based our analysis of the potential total costs of supporting the GSEs purely on their publicly available financial statements. Fannie Mae and Freddie Mac have not provided or validated any of the assumptions that we have used. Our primary goal is to offer investors an independent view on our assessment of the remaining credit losses embedded in the GSEs.
S&P also provides some additional unpleasant facts about the housing sector, which everyone but one Jim Cramer (who called the housing bottom last June) is all too aware of.
A Backlog Of Unsold Homes Is Exacerbating The Housing Slump
The U.S. housing market remained in a severe slumpthrough the first three quarters of 2010. As a result, we see very little momentum toward a more steady housing market in 2011. Despite reports of stabilizing mortgage delinquencies at Fannie and Freddie, we believe there is significant uncertainty related to the build-up in inventory, which is likely to continue to keep home prices down (see chart).
But these numbers don't reflect the store of seriously delinquent loans that could go to foreclosure (often called the "shadow inventory"). Standard & Poor's estimates that at the end of second-quarter 2010, the shadow inventory backlog would have taken the market just over 40 months to clear.
Moreover, we believe that Fannie Mae and Freddie Mac will continue to realize credit losses from their legacy portfolios over the next three to five years. The extent of those losses depend on, among other factors, the success of the newly initiated loan modification efforts and the ability to successfully resolve the foreclosure documentation issues that have arisen over the past few weeks. In addition, we are monitoring GSEs' success on their "put-back" efforts, i.e., their attempt to return to lenders mortgages they believe are based on representation and warranty breaches. We expect to see ongoing litigation over this contentious issue.