Tuesday, January 13, 2009

Should Fannie & Freddie Buy Up the Mortgage Market?

Sunday I invited comments on this idea, circulated by Bradford DeLong.

My favorite idea right now is that of nationalizing Fannie Mae and Freddie Mac completely and unleashing them to buy up every single mortgage in the country at market rates. Their ability to borrow at the Treasury rate means that they should be able to make money by doing this. When they own mortgages they can renegotiate and refinance them all with the public interest in mind. And as they squeeze banks out of the mortgage business the fact that banks are looking for yield should push other financial asset prices up—and make it possible for those businesses that should be expanding to get financing right now on terms that make expansion profitable.

Some reader responses:

Too clever by half. Only need to buy up risky mortgages to clean out the system. Need a clear, easily explained plan — a government offer to buy all subprime and ALT-A mortgages for 50 cents on the dollar. That's high enough to benefit all but insolvent banks, yet low enough to give the taxpayer a chance of making a buck.

Longer term — Canadian system, mandatory mortgage insurance whenever down payment is below 20%, and no mortgage interest deduction. Also margin requirement (loan to value limits) for mortgage backed securities, just like Fed has on corporate securities. Mystery why no one notices this major structural problem.

**

As an economist I have to say that [the idea] has some merit.

1. The infusion of cash into the banks while removing the primary source of risk in their portfolio would almost certainly drive up investment and likely break the lending logjam we are currently witnessing.

2. It is theoretically possible for Fannie and Freddie to make money at this endeavor given the availability of funds at treasury rates.

As is always the case in reality, though, there are one or two "unintended consequence" that could stem from such a policy:

1. The cash infusion would likely cause very high inflation rates, at least in the short term. This may not be inherently horrible, but it would likely cause a policy backlash with no way of knowing how it would play out.

2. This makes the Federal government the lienholder on the vast majority of property in the US. This is a situation ripe for "political entrepreneurship" (otherwise known as rent seeking). The question of Eminent Domain becomes almost moot because all the government has to do is foreclose on whatever homes they want to raze as a gift to whatever developer happens to contribute the most to their campaign warchest.

3. Fan and Fred become the SOLE source of mortgage lending. This means that a "one size fits all" approach will likely develop out of Fan and Fred. This is because they cannot afford to staff the numbers of people necessary to offer the number of options currently available through the market. Of course this is because the market operates for profit, where Fan and Fred would operate for the "public interest."

4. The "public interest" is a moving target and will be subject to political interpretation and manipulation. People who make the claim that policy makers will act in the "people's interest" forget that there are interpretations other than their own. On the other hand, the market is not subject to the kind of random manipulation at the whim of whomever is in office. This doesn't mean it can't be manipulated by lawmakers, but it is a much slower and less effective process. Imagine a political environment where if you have been turned down for a loan a politician then promises to "reform" Fan and Fred so as to make it impossible for them to turn down loans. In case you missed it, this was what started our current meltdown. So instead of having private institutions failing, Fan and Fred would fail (again), and this time they would represent 100% of the mortgage market.

...

Let's hope no one is paying attention to such ideas.

**

I'm not an economist but I am someone who has been around Wall Street and the CMO business for 20 years. The statement that banks are looking for yield shows that Bradford has a poor knowledge of the mortgage business. Banks don't make the interest off your mortgage and haven't for years. They are simply processors of the loan. They package those loans up and sell them to Fannie and Freddie. So they really don't care what the rate is. They'll get their processing fee and upfront fees for generating the mortgage but that is it.

Fannie and Freddie can't squeeze banks out of the mortgage business because they depend on each other to make it work. Plus can someone tell what the market rate is for a house when nobody is buying ? Don't forget it was mainly because Fannie and Freddie bought up bad loans and held on to them instead of securitizing them into bonds that we had to bail them out. In the end if nobody wants your CMO's you end up holding the bad loans and bad loans don't get better because of who holds them.

01/13 11:20 PM