Monday, August 6, 2007


A part of the solution to the illiquidity now savaging the mortgage market, adding to the woes created by subprime and beginning to infect the prime market, virtually is being ignored.

It doesn’t take and act of Congress, merely a decision by the White House that there’s less grief in going this route than hoping that the market smoothes itself out, and the sudden lender and investor failures, stop occurring.

The relief can come over night and in ways that the mortgage market and the broader debt markets understand and welcome.

The Administration should make the decision to take its political hand cuffs from Fannie Mae’s and Freddie Mac’s business operations and encourage the companies to pour billions of dollars of liquidity into he market, before more carnage occurs. In other words, let the GSEs do what they do best, until the market rights itself.

Unless the White House has a better answer, the nation’s mortgage market, and indeed the slumping economy, can only benefit if Fannie Mae and Freddie Mac are directed to go into crisis mode and are directed--in a major way--to purchase thousands and thousands of mortgage loans from originators and smaller investors, providing those less stable institutions with instant cash relief and keeping them out of financial “emergency room,” or worse—funeral homes!

Yes, Virginia, the GSEs then would keep the loans in portfolio or sell them to other investors. But that would be far safer regulatory move than a possible mortgage market meltdown, because the two companies are better able than virtually anyone else to manage those interest rate and credit risks explicit in mortgages.

Sure, there will be deals and “haircuts” (premiums, discounts and price cuts) all along the way, but it will be “the market” making those accommodations, not HUD in some bulky government plan or the Fed and Treasury suddenly pumping cash into one or more of the large investment banks or money center institutions, when it shockingly and without warning taps out on some sultry mid-week afternoon. And, GSE relief can flow quickly and efficiently, the minute the Bush Administration gives the word.

Why Wait?

Remember folks, “a stitch in time!”

If you can believe “the squirrels,” those chattering folks behind the scenes folks in DC, who spend their days exchanging stories and rumors, in return for more stories and rumors (one of the reasons why there are no secrets in DC), some mortgage interests already have approached OFHEO’s “Two Gun” Lockhart suggesting an “emergency” increase in the GSE mortgage ceiling, to allow Fannie Mae and Freddie Mac to provide liquidity for “non-conforming mortgages” (a term that historically has meant loans above the F/F mortgage ceiling). Others are wondering why “massive mortgage liquidity relief,” for the traditional “A” markets and subprime, can’t be provided by the two government sponsored enterprises, created for just that purposes.

Even Karen Shaw Petrou, an extremely capable financial services observer (and hardly a traditional friend of the GSEs), reportedly has speculated on Fannie and Freddie moving out of their historic “conforming” niche and--as an emergency gesture--helping provide liquidity to the aforementioned non-conforming lenders, with some tie back to the lenders providing relief to the subprime market. In a perverse way, the “systemic risk” facing America today is not the Fed created “GSE problem,” but it is an absence of liquidity starving other elements of the mortgage finance system, with the GSEs sitting there possibly as a major part of the solution, but currently handcuffed.

Leadership in Congress and Downtown

For Fannie Mae and Freddie Mac, operationally, to provide all of the liquidity that the mortgage markets require, it will take a knowledgeable and motivated Bush Administration and an equally cooperating Congress, willing to stand up together and share some of the responsibility (and political reward) for calling on the GSEs to deliver this “liquidity Care Package,” to lenders throughout the nation. It also will require that OFHEO work cooperatively with the companies and drop its institutional adversarial persona. (I wonder if TG and his handlers see the golden opportunity here for them.)

Someone, let’s say the bi-partisan leadership of the Senate Banking Committee and the House Financial Services Committee, should communicate with the Treasury, OFHEO, and the Fed, and suggest—administratively—that the GSE regulator give Fannie and Freddie “a mortgage purchase green light,” through the end of 2007, to provide the liquidity that the mortgage markets demands (conforming and no-conforming).

The broader economy, as well as the mortgage sector, can be monitored--regularly-- during that time to see if markets have calmed and it’s appropriate to go back to the buttoned-up Fannie and Freddie, or if more GSE purchases are required.

Congress is gone for the summer, but it doesn’t require passing a law to accomplish the necessary complementary effort I’ve described, just a top staff driven letter, on the appropriate letterhead, blessed by the four congressional principals.

The Democrats run Congress, not the GOP. Sen. Chris Dodd (D-Ct.) and Rep. Barney Frank (D-Mass.) might not want to wait for their GOP colleagues to sign up, if they think the action makes sense.

Of course the Administration could act unilaterally and might have to swallow some of its politically motivated “systemic risk concerns,” which currently hamstring the companies. But what’s worse, if the Bush White House swallows a little of its political hyperbole or hosts an unfolding financial disaster, leaving valuable tools unused on the side of the road?

A thoughtful Bush Administration also should realize that the two GSEs are easier to oversee for possible “post-purchase surge” problems (since OFHEO has staff living in both companies) than to tightly monitor a thousand lenders, real estate investment trusts, and Wall Street firms, any one (or more?) of which the Fed and Treasury might have to bail out, using the Long Term Capital Management precedent of “too big to fail.”

Will a Timely Half Trillion Dollars of Liquidity Help?

I have no idea how big the “mortgage problems” might be and how much relief is necessary before the market settles, but let’s assume that, together, Fannie and Freddie might have to bring $500 billion of help (that’s a half trillion dollars). If you added that mortgage amount, proportionately, to the two companies portfolios, that only would increase the GSEs portfolios to where they were a few years ago, meaning that portfolio level is not without precedent.

Policy makers should make this change NOW, not after more major market carnage. Activating Fannie and Freddie is also the kind of thing that—following a disaster—some bipartisan commission will ask, “Why didn’t the White House and Congress employ the GSEs to….?”

Someone should put the question to Chairman Bernanke, “Ben, should we let Fannie and Freddie try and let the air out of this mess, now, while there still is some calm in the market, or should we wait for one of the big investment banks to faint dead and then let you and Treasury try and put Humpty Dumpty back together?”

Is the White House creatively up to employing the GSEs to do what the companies were created to do, or will the Administration hold onto its political ax and risk some collapse in a crucial economic sector, only to call on the GSEs for help after housing hits the fan????

The proposition represents a very small downside and a huge upside for the economy and the country.

Maloni 8-6-2007


John M said...

Sorry, didn't see your post until I finished mine (you were mentioned, but on an old issue). I'll need to respond separately. See you soon!

Bill Maloni said...

JM--As you pass me going up the "stairway to fame," just say "Hi."

Bill Maloni said...

Let me--again--apologize to the readers for some typos and pledge to do a better job.


John M said...

Hi Bill,

Don't sweat the typos, it's the content that's troubling. I've now posted my reply here: " GSEs Unchained? Let’s Think Hard".

Daniel said...

This would be fine if the liquidity shortage were due to some failure in the market. But I think the liquidity shortage is rectifying a previous failure. Too many of those subprime and Alt-A loans are doomed to default, and the market is finally recognizing that. Now that housing is not rising at double digit rates, nobody in the private market wants this toxic waste anymore. So why should the GSE's?

John M said...

Hi Bill, Just caught your CNBC spot and I've put a link to it on a new post at Housing Doom.

Bill Maloni said...

Daniel--Various ways to look at the illiquidity in the subprime market.

Fannie and Freddie already have offered to invest some $40 billion, between them, in buying some of those SP assets, from lenders/investors which might just mean the difference in survivability to those shops.

Equally, now that Fannie has asked OFHEO for investment cap relief, the regulator might--in return for agreeing--direct Fannie (and Freddie) to do more in SP (look closely at Fannie's need for OFHEO's OK for the reported C-Bass servicing operation acquisition).

Also, some of those junk loans might be suffering from "guilt by association illiquidity" or GBAI.

That's a joke. But even if you have 25% default in the SP product originated two or three years ago, that means 75% is performing, but maybe stuck in limbo because of what they represent. F/F might be able to bring in some relief to that paper and help those investors, thus playing their traditional role "providing liquidity."

Nobody can make chicken salad out of chicken crap, but there are things that the GSEs can do, here and in the "jumbo market," if OFHEO is both flexible and creative.

Bill Maloni said...

It's midnight on Thursday and this blogger's going to bed, after a long day.

I drafted a new blog, but don't know if I have the time to get it out tomorrow, since we are headed out of town for a long weekend.

It's commentary on the sad Bush press conference reaction (twice!!) to the Fannie request and why he's painted his Administration unnecessarily into a corner, something he didn't need to do. No wonder we are stuck in Iraq!!

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