Monday, January 11, 2010

Housing - the new healthcare?



Healthcare healthcare healthcare. It's an albatross and its all that we hear about. It's sinking the nation with its high costs and increasing costs. Reform must happen or else we'll all perish.

Fine. Right or wrong. Whatever. But what I'm concerned about is the part of our economy that started the recession we've just escaped. The part of our economy that was originally free-market, then mostly-free-market, and is now becoming subsidized and increasingly government supported/owned. Support is reassuring in desperate times, but government support has never proven to lead to efficiency and profitability. More imporantly, government support has always shown extremely difficult to remove once its firmly established.

So consider housing -- Fannie and Freddie were quasi-government entities that had the role of supplying mortgages, buying mortgages and then repackaging them for sale (to raise capital so more mortgages can be issued) on liquid secondary markets. Fine, the problem came when mortgages were being issued with 0% down to people with inadequate income streams to cover mortgage payments. That means defaults and loss in equity (which we've now seen). That also means Frannie and Freddie got real risky and now have real losses -- mind you, government losses = taxpayer bills.

Here's what's unfolded lately:
(1) The treasury department said it would back Fannie/Freddie losses for up to $200 billion. As of year end 2009, they had used up $111 billion. Mind you, this is an unprofitable business -- most such businesses would have to close shop - but a government business involved in housing simply cant. So the problem grows. Feeding a blackhole.
(2) Seeing more substantial losses on the horizon, the treasury says it will now lend UNLIMITED SUPPORT to Fannie/Freddie to cover losses!! It EXPECTS $400 billion in losses, but you dont lend UNLIMITED support unless there is potential for worse.
(3) To stop the risky behavior of Freddie/Fannie, treasury had set plans in place to ensure that the mortgage portfolios of F/F would be reduced by 10% by end 2009. The idea = reduce mortgages = reduce risk = reduce losses = restore a sustainable business model. Oh yeah -- the treasury said, now, that in order to prevent home prices sinking further, more mortgages are needed to support a revival in demand in the housing market. Thus, they are going to EXPAND their mortgage portfolios, instead of reduce them.

The implications of this are inevitable....
(1) Permanent governmental housing support = another taxpayer drain, another drain on capital flowing into otherwise private or profitable ventures, another socialized nature of the economy
(2) A failure to stop giving our loans and creating false demand only delays the inevitable -- which is a spike in foreclosures and further decreases in home values.
(3) Defaults and foreclosures will rise partially because strategic defaults by homeowners will be worth considering and the irrelevant stigma that foreclosures used to imply wont matter as much to homeowners.

The solution = banks need to take the losses, and so do F/F. This is somewhat what was expected when the financial meltdown was occuring in last 2008 and early 2009. It turned out through valuation mechanisms and government support that banks didn't have to take their losses, which meant they weren't as financially in peril as expected, which meant stock prices rose, which this (combined with liquidity and $s being pumped into the economy via stimulus) means that the markets rise. So we've got a high market, higher stock valuations, a stabilized housing -- and its all on the back of the taxpayers. Avoiding pain now results in hampered growth and potentially greater pain in the future.

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