Housing, debt ceilings & zombie banks
In a Washington Post report this week, the Obama Administration was said to have decided to adopt a proposal to continue a major government presence in financing mortgages. The Treasury subsequently denied this report in a statement posted by Deputy Secretary Neal S. Wolin:
“The Obama Administration believes that the private sector – subject to strong oversight and consumer protection – should be the dominant provider of mortgage credit. That’s why, in each of the three options we outlined in our report to Congress, the government’s footprint in the housing finance market will shrink substantially. That’s why, in each of the options, any government support for housing finance will be targeted and limited. This will help ensure that taxpayers are protected and the private sector bears the burden for losses.”
Would that any of this were really true. Let’s go through this statement and pick out some of the more notable canards and omissions of fact. First and foremost is the idea that the private sector is willing to take a leading role in housing finance in the U.S.
Since the 1930s, the U.S. has used a full-faith-and-credit guarantee for housing finance to turn disparate home mortgage notes into commodities attractive to investors. The private mortgage market prior to the Great Depression and the New Deal is not comparable to the government-sponsored market for agency securities today, investment paper that is a close surrogate for Treasury debt itself.
The largest portion of the market for residential mortgage backed securities or RMBS has been government sponsored for 80 years. By extending guarantees to private mortgage paper, banks were able to package the notes from each home mortgage and sell securities to investors backed by these notes. This virtuous cycle provided liquidity for the banks, which recovered their principal and then were able to make additional home loans. That cycle is now broken.
The role of the private sector in the RMBS market has been limited at best with private investors buying significant quantities of non-guaranteed paper only during times of market exuberance in the past decade. Today banks are avoiding “first loss” risk on U.S. real estate and instead write almost all of their loan production to be guaranteed by one of the three housing agencies — the FHA, Fannie Mae or Freddie Mac. Almost all of this flow of “new” loan business is refinancing for better borrowers.
This brings us to the second fallacy in the debate over the future of the government role in housing, namely that the current policy is meant to protect the taxpayer and the public generally. You may have noticed that the Obama Administration has started to talk about creating opportunities to turn foreclosed properties into rental housing, a common-sense initiative that is born of necessity. Hold that thought.
Empty homes represent tens of billions in future losses to the Treasury. When the house is sold, the government takes the loss. Thus the last thing either the Treasury or the White House wants to see is any effort to move the restructuring of the housing sector or the largest banks before the 2012 election. Delay means higher cost to the taxpayer.
We talked about the need to restructure Bank of America as a precursor to clearing the U.S. housing market in an earlier post on Reuters.com, “Uncertainty and indecision threaten Bank America and global markets.” But given the recent debate over the debt ceiling, President Obama does not want to tell Congress that he needs at least a $1 trillion in borrowing authority to fix the GSEs and the largest banks. Politics is the chief obstacle to fixing the housing mess.
Attorney Fred Feldkamp reminds us that “we knew virtually all the Texas S&Ls and banks were broke by 1984, but we could not get Congress to permit enough coverage in the federal debt limits and restructuring costs to close the vast bulk of them until FIRREA was passed in August of 1989,” he recalls. “Even then, Congress tried to renege on the 1988 deals that kept the S&L problem from becoming twice as large. It wasn’t until 1996-2004 that the people who were promised the 1988 deals received what they bargained for.”
One of the reasons that I have pushed for an FDIC resolution of some of the huge housing exposures facing the largest banks is that the cost can be kept off the federal budget. FDIC is an industry funded mutual insurance scheme with powerful receivership and debt issuing authority, especially with the Dodd-Frank legislation. The U.S. banking industry, not the taxpayer, has always paid to clean up the mess in previous crises via the FDIC. The present housing crisis demands a similar response.
If the banking industry were to use the FDIC to restructure BAC and other large lenders, then immediately spin the smaller, better capitalized banks back into private hands, this would not only help Washington to focus scarce public resources on the losses inside the major housing agencies but would also greatly rehabilitate the industry’s public image.
Americans need to see some good examples of civic action, instances of private people and companies moving with purpose to solve our national problems. A private sector approach to the housing problem, using the industry funded vehicle at the FDIC to restructure some of the largest banks and breath life into moribund housing assets, could be a powerful tool to that end. But do we have the courage and the vision to make it happen?