Mortgage Crisis Means No Tighter Regulation Of “government sponsored enterprises” (GSEs)

I cover the refinance industry here.

David Smith writes:

Roughly ten days ago, the Administration officially flew the white flag in attempting any further regulation of the GSEs.


White_flag

Legislation not pending?

 

As reported by The Wall Street Journal, with its usual Burma-Shave sub-headlines:

 

U.S. Puts Faith in Fannie, Freddie

Firms, Once Hemmed In,
Are Freed for Bigger Role
In Aiding Mortgage Market

 

Trapped_in_the_ice

We’re constrained as to our market movements

 

Federal regulators, in an effort to contain financial turmoil, are handing government-sponsored companies an even bigger role in propping up the mortgage market.

 

Officials affirmed yesterday that government-sponsored mortgage investors Fannie Mae and Freddie Mac will enjoy loosened capital requirements, allowing them to pile more mortgage securities onto their balance sheets.

 

Torching

We’re working on the executive summary right now

 

Two years ago in the ongoing Fannie Mae story, when the blistering OFHEO report came out, I posted at length about the multi-billion-dollar risks to taxpayers of GSEs turbocharging their balance sheets. 

 

Fannie and Freddie could purchase an additional $200 billion of mortgage securities, equivalent to about 10% of expected U.S. home-mortgage lending this year. The two also plan to raise new capital.

 

I believe, as do many others, that this was an explicit quid pro quo negotiated by Secretary Paulson, with the GSEs being given the latitude to make a lot more money by boosting their balance sheets, but at the price of raising more equity capital.

 

Regulators in the past few years have required Fannie and Freddie to hold 30% more capital than their usual minimum while they fixed problems with their accounting and risk controls, a process now viewed as virtually complete. That capital surcharge is now falling to 20%.

 

Under the lower surcharge, Fannie and Freddie must hold capital equivalent to 3% of the mortgages they own, down from 3.25%. That, plus additional adjustments on the capital required for loans guaranteed by the companies, frees up about $6 billion in capital that can support $200 billion in additional mortgage holdings.

 

Meanwhile, the companies have indicated they intend to raise similar amounts in new capital, probably by selling preferred shares. Details haven’t been determined.

 

That last fragment is a clue about who promised what to whom.

 

Promises

Promises?  Who makes promises?

 

As I posted in Banking on value, the Administration’s domestic policy makers — Fed chair Bernanke, Treasury secretary Paulson, and their counterparts – have been comprehensively adding liquidity to the system, by opening all the financing valves they can reach:

 

Mechanic_opening_valve

Get those secondary loan markets moving!

 

The Feds aren’t just opening the bank petcocks, they’re turning on all the liquidity taps:



 

Water_tap_on

More liquidity where that came from
 

The government will also accept mortgage-backed securities issued by government-sponsored companies like Fannie Mae and Freddie Mac.



We’ve previously seen that the GSEs enjoy awfully big advantages, which lets them rapidly grow or even turbocharge their balance sheets.  That brings a lot of risk, but it also brings benefits, one of which is on display here: the GSEs can be open 24/7 if the Fed lets them. 

 

Macro-economically, as I said last Monday, it’s the right thing to do:

 

The moves could help keep interest rates low for home buyers.  Rates on mortgages rise when investors in securities backed by such loans demand a premium to compensate for what they see as growing risks.  Aggravating that problem, some financial institutions that hold mortgage securities have been dumping them to raise cash.

 

That mortgages are sold has created a truly paradoxical consequence: because they could be sold, they were being sold, simply to raise cash to cover less liquid objects.  With all the banks facing the same problem, the rush of sellers of perfectly good products was depressing their price.

About Luke Ford

I've written five books (see Amazon.com). My work has been followed by the New York Times, the Los Angeles Times, and 60 Minutes. I teach Alexander Technique in Beverly Hills (Alexander90210.com).
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