Blown Mortgage

If Fannie and Freddie fail the price tag is somewhere between $400 billion and a shade over a trillion of taxpayer money to bail them out. How do you like them apples? A trillion bucks? Big enough to sink the government’s AAA rating. Big enough to make LTCM look like child’s play. This is some scary stuff folks.

Some comparisons shall we?

Clinton’s proposed universal health-care coverage
10-15 years of Obama’s plan @ $50-65 billion per year
Cost of the Iraq war

From CNN’s trillion-dollar mortgage time-bomb:

Although few are predicting an imminent need for a bailout just yet, credit rating agency Standard & Poor’s recently placed an estimated price tag on this worst case scenario — $420 billion to $1.1 trillion of taxpayer’s money.

This dwarfs how much it cost to help banks during the savings and loan crisis of the late 1980’s and early 1990’s. That cost taxpayers about $250 billion in today’s dollars.

S&P added that saving Fannie (FNM) and Freddie (FRE, Fortune 500) might cost so much that the federal government’s AAA credit rating, the top possible rating, might even be at risk. If that was lost, then all federal government borrowing would become more expensive.

But other experts expect that declining home values will force more borrowers who have a Fannie- or Freddie-backed loan to stop making payments in the coming months, rather than continuing to make payments on a home now worth less than their loan balance.

Rising job losses may also make it difficult for other borrowers who formerly had good credit to stay current on their mortgage payments.

“The real fundamental problem is real estate prices have been falling and they might fall substantially more,” said Robert Shiller, a Yale University economist who argued for years that a bubble was forming in real estate prices. “OFHEO and Fannie and Freddie never considered the possibility of a massive real estate correction.”

Some economists suggest that if investors start to see problems in the performance of loans backed by Fannie and Freddie, they’ll dumping them. And that would force the federal government to step in.

“I would say there’s at least a 50-50 chance of some sort of bailout. I’m not saying it will necessarily cost $1 trillion, but they’ll need some kind of help, and it very well could happen this year,” said Dean Baker, co-director of the Center for Economic and Policy Research

Investors are signaling growing concern as well. The yield premium for securities backed by Freddie and Fannie compared to the yield on Treasury bills has grown to about 2.25 percentage points from 1.7 percentage points at the beginning of the year. That’s a sign that the investors see a greater risk of Fannie and Freddie running into bigger problems.

I’m guessing there’s a school, a child, a homeless person, a neighborhood, a teacher, a firefighter, a veteran that could all use more help - I hope we don’t end up costing them that help by recklessly throwing Fannie and Freddie in front of this train.

And Fannie and Freddie’s role in the mortgage and real estate markets is likely to grow, as Congress recently allowed them to back larger mortgages, up to $729,750, up from the previous limit of $417,000.

The Office of Federal Housing Enterprise Oversight (OFHEO), which regulates both firms, also recently lowered the capital requirements for Fannie and Freddie in an effort to pump $200 billion more into the credit markets.

The new loan limits will increase the risks and losses for Fannie and Freddie, said Wagner and other experts.

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This is a couple of days old - and I’ve received several emails as to why I haven’t blogged about it yet. The answer is that while the news of the GSE picking up jumbo conforming loans is, in fact, news, the bigger story is that there hasn’t been much of an appetite for these loans through any channel. First let’s talk about the news of Freddie Mac purchasing jumbo conforming loans (up to $729,750) as part of the Economic Stimulus Act.

From CNN on Freddie Mac’s announcement:

The McLean, Va., company said the financing is part of the Economic Stimulus Act, which temporarily raised Freddie Mac’s conforming loan limit to $729,750 from $417,000. The purchases are limited to 224 high-cost markets where median home prices exceed its original loan limit, the company said.

Freddie Mac intends to buy jumbo mortgages from Wells Fargo & Co. (WFC), JPMorganChase & Co. (JPM), Citigroup Inc.’s (C) CitiMortgage, and Washington Mutual Inc. (WM). The jumbo mortgages purchased by the housing finance giant will be full documentation loans, that is, not Alt-A mortgages that lack verification of income and assets, said Brad German, a spokesman at Freddie Mac. It may buy mortgages dating back to July 1, 2007, in line with guidelines under the Economic Stimulus Act, he added.

Freddie Mac’s naming of the top institutional investors is interesting. I’m not aware of this being an inclusive list but it is curious that they singled out those institutions explicitly in the announcement. If anyone knows if this is exclusive to the above-mentioned banks let me know. If that is the case it certainly does constrain originators and consumers looking for these loans.

No appetite for conforming jumbo?

The more interesting part of this story is that the new jumbo conforming loans are already a ‘non-starter’ in the finance world. With interest rate spreads of 75 to 100 basis points above the ‘conforming’ conforming rates there has been little volume for any of the new products.

In fact, Mr. Mortgage is calling the new products a ‘bust’ already. From Mr. Mortgage’s post on the bust of Fannie and Freddie jumbo conforming loan offerings:

Just got off the phone with three of my top contacts at three of the nations leading mortgage lenders/banks. These programs are not selling at all. The volumes are very low. Banks are highly disappointed. The difference between a standard Fannie/Freddie (Agency) is roughly 75 to 100bps depending on the lender. Agency 30-yr fixed are roughly 6.25% with no points and Agency Jumbos are roughly 7 to 7.25%. Mortgage rates have gone up about .375% in the past few days.

In a nutshell, the new Fannie/Freddie jumbo programs are already a bust. They offer nothing to most people other than the few with perfect credit, who have a large down payment and make tons of money.

Pushing on a string

As we’ve discussed before efforts to improve liquidity are like pushing on a string. The government can roll out program after program but the fact of the matter is that we are not in a liquidity crisis (although Wall Street is) but a solvency crisis.

From Mish Shedlock’s excellent blog post on the subject back in January:

The crisis we are in now is a solvency crisis, not a liquidity crisis. There are no bigger bubble to be blown that will provide jobs and allow consumers to pay debts.

People have maxed their credit, are in near-zero or negative-equity positions and no matter what loan limits are or how much Fannie and Freddie can buy there won’t be a ’saving’ of the housing market. (Which I think is a good thing.)

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