As Obama and Congress fiddle, America liquidates housing sector

March 29, 2011

Republicans in the House of Representatives are busily assembling several legislative proposals to reform the housing sector and reduce government support for the secondary market in home loans used by banks to manage their liquidity.

According to Joe Engelhart at CapitalAlpha Partners: “House Republicans are considering an ambitious series of standalone legislative initiatives to reduce the role of Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) over the next five years.”

Meanwhile, President Barack Obama has started another war in the Middle East with his political soul mates in the EU.  The President has also embarked upon an ambitious schedule of foreign tourism and domestic campaign stops, but nothing of substance.

Obama is compared by some to Louis XIV XVI (and Mrs. Obama to Marie-Antoinette)  in terms of his detachment from the nation’s priorities, particularly the ongoing meltdown in the housing sector.

“Pres. Barak Hussein Obama has given new meaning to that epithet “imperial presidency,” my friend Sol Sanders opines.  “It was slung at Pres. Richard Nixon not only for his extravagant “palace guard” — some in kitschy uniforms — but his more serious unconstitutional overreach.  But if imperial in his style, Mr. Obama reigns; he does not rule.”

In many ways, the current national policy mix of more regulation, decreased government subsidies and, to add further urgency, a shrinking banking system, is the perfect storm for the housing, which is now down six months in a row.  Despite my long-held desire to see market-based reform in the US housing sector, I think all parties need to be aware of the precarious situation facing the American economy and banks as home prices collapse for lack of credit.

The slide in home prices and receding bank lending footprint is one of the reasons why at my firm we have begun to talk about putting aside structural reform of the housing sector this year and instead increasing the size of the loans guaranteed by the government, even while raising the cost of such “g fees” as they are called by housing market mavens.  Without credit, the real estate sector is left with a cash market liquidation with grave implications for financial intermediaries and investors.

We wrote this week in The Institutional Risk Analyst, “Wanted: Private Investors Seeking First Loss Exposure on RMBS, March 28, 2011,” about some of the details of the secondary mortgage market.  In simple terms, there is about $11 trillion in financing behind the real estate sector: $4.4 trillion in the portfolios of banks, $5.5 trillion in agency securitizations guaranteed by Uncle Sam, and $2 trillion or so in private label securities.

In order to believe the claims of my conservative friends about “reform” of government agencies like Fannie Mae and Freddie Mac you must believe that some of the $5.5 trillion in no-risk agency securities is going to be willing to migrate into the bucket of private label securities, where investors take actual credit risk.  It is unlikely that we are going to see any significant increase in the private market home loans unless interest rates rise significantly.

The net, net here is that the available pool of credit available for the housing sector is shrinking and thus prices must also decline to adjust for that supply of credit.  This fact of continued decline in home prices is going to have a chilling effect.

As we wrote in The IRA this week: “It is no accident that states such as Illinois, Nevada, Missouri, and Maryland are all considering legislation to ban appraisers from using involuntary foreclosure sales in home valuations. In a rational world where programs such as HAMP were really effective to restructure underwater loans and, of necessity, say 50% of all HELOCs were written down to zero, both the Too Big To Fail banks and the private mortgage insurers would be insolvent. ”

This week regulators are starting to work on the risk-retention rules of the Dodd-Frank legislation, yet another point of friction that is making it more difficult for Americans to obtain housing credit.  The political fight over what constitutes a “qualified residential mortgage,” which does not require banks to keep 5% of the risk, will only marginally effect the deflationary forces now working on the housing sector.

While the media will be fascinated by all of this insider play over the “QRM”, the real story is out in the housing market, where more than half of all home sales this year will be involuntary foreclosure liquidations.  The slow erosion of home prices is likewise eating away at the willingness of lenders to take risk in real estate, thus the 4% decline in loan balances YOY according to the FDIC.

I estimate that Fannie and Freddie alone are hiding $200 billion worth of bad loans on their books simply because there is no market for these foreclosed homes.  Ditto for the largest servicer banks such as Wells Fargo, Bank of America, JPMorgan Chase and Citigroup.  To clean up this mess with finality is going to cost $1 trillion or so in round numbers.  But nobody in Washington wants to go there.

The Obama Administration and the Congress need to put aside their respective fantasy world views and focus on the horrible economic reality ongoing in the housing and banking sectors.  It may be that the degree of self-delusion in Washington has reached the point that only another financial catastrophe can wake us from out collective distraction.  But if President Obama really believes he can win reelection with housing prices falling from now till November 2012, then perhaps those who liken him to Louis XIV XVI are right.

Editor’s Note: The piece has been updated with the correct regnal number for Louis.


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[…] As Obama and Congress fiddle, America liquidates housing sector. […]

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[…] As Obama and Congress fiddle, America liquidates housing sector Chris Whalen, Reuters […]

Posted by Links 3/30/11 « naked capitalism | Report as abusive

We need to clear the market by reinstituting something like the Home Owner’s Loan Corporation process. During the depression, this agency took illiquid underwater mortgages off bank’s books in exchange for bonds. It then refinanced the loans for the homeowner. To some extent we have already started clearing the bank’s books.

Until we do this completely in a workmanlike manner, the overhang of unrecognized losses on bank balance sheets, combined with locked in, terrified homeowners will keep our economy in a zombie state.

Posted by furiouschads | Report as abusive

I think referring to Louis XVI, who was married to Marie Antoinette, and overthrown. Louis XIV was very savvy: “L’etat c’est moi.”

Posted by egreen711 | Report as abusive

The key is, as I believe your referenced post of March 28 suggests, is that what you refer to as the MI industry is always been a Ponzi scheme scam where risk has been purposely under estimated with the assumption that housing prices “which never fall” along with market inertia will overcome the hopelessly flawed business model. Whether the participants are criminals or not is apparently up for debate. The answer IMHO is for the MI to adopt the model of the surety industry. Instead of “insuring” the mortgage in excess of 80% LTV, MIs would act as a surety. What this would mean is that MIs would of necessity seek and obtain additional collateral, co-signers and other security that would preclude a borrower from merely walking away from a mortgage and saying “never mind”. In the case of default, the surety would have the legal obligation to pay up the mortgage holder and then have a legitimate opportunity to recoup from the borrower. Maybe some additional legislation would be required to assist in that mission but, as surety companies demonstrate many times each day, it is a business model that has stood the test of time.

The preeminent issue IMHO is that the borrower must have some skin in the game. That can occur only if the borrower is truly on the hook for some reasonable portion of the purchase price (we can argue about 20%+-). The current business model of MIs must be recognized for the scam it has always been before any improvement in the mortgage financing market can occur. Obviously my suggestion is easier said than done, but that is where political leadership is of critical importance.

Posted by Paca | Report as abusive

Not to quibble, but it was mentioned twice–I think you mean Louis XVI, not XIV. Louis the XIV was a very effective leader (the “Sun King”). Louis XVI was married to Marie Anntoinette and was the only French King to be exeucted by his subjects.

Posted by bogrady | Report as abusive

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Posted by As Obama fiddles, America liquidates its housing sector | Report as abusive

Possibly the dumbest commentary on the presidency I have ever read. There’s just no place to begin. Moronic.

Posted by jerseycity64 | Report as abusive

Louis XIV married Maria Theresa and presided over one of the golden ages of France. Surely you don’t want to compare Louis XIV to Obama and the housing slump.

Posted by Tobyh | Report as abusive

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Posted by Heir Today, Gone Tomorrow | | Report as abusive

You would think that in a time of quandary – the exact definition of what constitutes a QRM – whether it be an ethical canon or prudent step, erring on the side of caution in the given formula would not only alleviate the greater moral hazard but also possibly restore some equity, and quite possibly confidence, in the home mortgage market.

Posted by Laster | Report as abusive

All Ponzi schemes evenyually crash. That would be the Fed and anything tied to finance.

Posted by robertsgt40 | Report as abusive

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Posted by Chris Whalen: Largest Banks Hiding $1 Trillion In Bad Loans | Japan Earthquake 7 | Report as abusive

The reason the housing bubble inflated is because there was a disconnect between borrowers and lenders. The disconnect was facilitated by Nationally Recognized Statistical Organizations (Fitch, Moody’s, S&P) and government guarantees and by government loan guarantees.

Twenty percent down and requiring originators to keep a large proportion of the loans they fund on their balance sheet would fix the problem. In fact it would have prevented the problem from occurring in the fist place.

Central planners always have such complicated solutions.

Posted by DiegoForever | Report as abusive

[…] Reuters reports that banks are still in deep deep doo doo: In simple terms, there is about $11 trillion in financing behind the real estate sector: $4.4 trillion in the portfolios of banks, $5.5 trillion in agency securitizations guaranteed by Uncle Sam, and $2 trillion or so in private label securities. […]

Posted by Housing Double Play: The Re-Melt-Downatization of America’s Housing Market | The Fringe Economist | Report as abusive

[…] are more than enough legitimate grounds for going after him.Friedrich Hayek, Zombie Paul KrugmanAs Obama and Congress fiddle, America liquidates housing sector Chris Whalen, ReutersForeclosure Aid Fell Short, and Is Fading New York TimesWhere the Bailout Went […]

Posted by Links 3/30/11 | Jackpot Investor | Report as abusive