As Obama and Congress fiddle, America liquidates housing sector
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.