June 24, 2008

JustQuotes: The Big (As In Jumbo) Difference Between Can And Are

"Three months after Fannie Mae and Freddie Mac won the freedom to step up home-loan purchases, the government-chartered mortgage-finance companies are doing what critics in the Federal Reserve and Congress had predicted.

Instead of using powers granted by Congress to buy jumbo loans for the first time, Freddie Mac and Fannie Mae are purchasing their own mortgage-backed securities, helping reduce losses, company filings show. The large loans, above $417,000, made up almost a third of the U.S. market last year, according to the Mortgage Bankers Association.

Since the rule change took effect in March, Fannie Mae has packaged $24 million of jumbo loans into securities, while Freddie Mac added $220 million, according to the Inside Mortgage Finance newsletter. In April, the companies spent more than $32.4 billion to buy their own instruments, regulatory filings show."

Fannie, Freddie Fail to Relieve Housing by Shunning Jumbo Loans [Bloomberg]
If Lowering Rates Isn’t Working, Perhaps Increasing Limits Will [SocketSite]
If The Plugged-In Readers Are Right, Jumbo-Conformings Are Here [SocketSite]

First Published: June 24, 2008 8:15 AM

Comments from "Plugged In" Readers

I doubt this is a surprise to many. Remember, Fannie and Freddie are PRIVATE companies that want to post profits. They have horrible balance sheets and have a high probability of being insolvent.

There were people who were worried this exact thing might happen. That said, some people wanted this to happen. the reason is somewhat convoluted.
A few months ago the Jumbo market was on life support, and the regular conforming market was having problems. Fannie and Freddie were posting big losses, and expected to continue to do so. Thus, Fannie and Freddie could theoretically have gone under, wiping out the regular conforming market.
By their actions, they are bolstering their balance sheet. They aren't lending to the Jumbo markets, but those markets were doing poorly anyway and probably can't be saved. but their improved balance sheet allows them to lend in the conforming markets which might be saved. Yes, CA, NV, AZ and FL will continue to see pain. But perhaps markets like IL, MN, MA, NY, DC, TX etc can be kept going.

so the true target may have been the conforming market, not the Jumbo as was claimed.

the money quote from the bloomberg article:

The companies' purchases of their own securities are making them riskier because they retain 100 percent of the credit and interest-rate exposure on those assets, said William Poole, president of the St. Louis Federal Reserve until March and now a senior fellow at the Cato Institute.

``Any legislation today that simply expands what they do is going in the wrong direction,'' Poole, 71, said. ``It's potentially digging the taxpayer in deeper.''

why yes it does. And this is no surprise. Fannie and Freddie will almost assuredly need a bailout at some time. it will be paid for by the taxpayers. This is the grand setup. The banks and investment banks are in trouble. fannie and freddie are in trouble. It is dicey bailing out private banks (see Bear Stearns). so offload as much risk as you can onto Fannie and Freddie. their accounting is opaque, their books are opaque. nobody quite knows what's in there. It's perfect. it will be years before they acknowledge their losses. They now have around 80-90% of the mortgage market and thus they are too big to fail. Few will make a peep when they are bailed out. and even fewer will connect the dots that much of their failure was caused by Goldman Sachs, Citigroup, Washington Mutual, and similar.

this is coordinated by federal reserve dropping the FFR and using it's lending facilities. this is giving banks (and now investment banks) cheap capital. The FFR went down 3.25%. but new mortgage rates and carloan rates didn't drop that far. why? because the banks get the spread (and due to risk premium). it is allowing the banks to pull in cash that they can then use to partially offset the billions of $$$ of losses they have on their books.

conspiracy theory? maybe. I think of it more as the only way to smooth the downturn. A collapsing RE market and collapsing mortgage security market could pull down the entire American financial system. However, it can survive a very slow degradation. That is what we are seeing. It is what we will continue to see.

Posted by: ex SF-er at June 24, 2008 9:02 AM

Entirely correct.

What we're seeing is just a slight twist on the Japanese strategy of "zombifying" banks. Instead of zombifying the publicly-traded ones, we're bailing them out and zombifying the GSE's so the taxpayers, instead of shareholders/debt holders will be on the hook. But the end result is the same--a longer, more drawn-out R.E. bust, with even more destruction of the average person's finances (home price declines AND tax hikes, woohoo!)

Posted by: David at June 24, 2008 9:33 AM

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