Live from Austin!

Once upon a time, the US government set up three agencies to provide home loans to people.

The Federal National Mortgage Association (FNMA) was founded by FDR to improve the liquidity of the mortgage market. It sits in between the mortgage borrower and the lender. Its job is to assume the risk of mortgage default, in return for a fee. In the 1960s, part of it was removed from the federal balance sheet by spinning it off into a private corporation. It was replaced by…

The Government National Mortgage Association (GNMA), part of the Department of Housing and Urban Development (HUD). GNMA bundles mortgages into securities which it guarantees even if the mortgages default, and then sells them on to big investors. It handles mortgages for veterans and native Americans.

The Federal Home Loan Mortgage Corporation (FHLMC) was set up in 1970. It basically does the same job as the FNMA, and was set up to provide competition for that organization.

In addition, the The Federal Agricultural Mortgage Corporation (FAMC) provides loans for agricultural real estate and rural housing.

Finally, the Student Loan Marketing Association (SLM) was set up to provide federal student loans.

Before long, people working in the housing industry came up with names that were easier to say and remember than the abbreviations the government used. FNMA became known as Fannie Mae, after the candy company Fannie May. GNMA became known as Ginnie Mae, and someone came up with Freddie Mac for FHLMC, presumably because the H is silent.

By the mid 80s, all the government agencies were called Mae or Mac; the FAMC became known as Farmer Mac and SLM became known as Sallie Mae.

Once the slang names became sufficiently entrenched, several of the organizations decided to officially change their names to the slang versions. Hence, FNMA’s logo officially says FannieMae, and FHLMC’s says Freddie Mac.

Before long, some private corporations worked out that they could suggest that they were big government-backed outfits by naming themselves something ending in "Mae" or "Mac", without technically lying to customers. Hence a bank in Pasadena called itself IndyMac, and one in Brea called itself ResMae.

Fannie Mae and Freddie Mac have ended up guaranteeing almost half of the mortgages in the US, for a total of around $5.3 trillion. Since they were officially run as private corporations, they were able to spend a lot of money ensuring that they remained unregulated and able to invest in subprime mortgages–i.e. mortgages that the borrowers would never be able to pay back, in quantities large enough to ensure that the CEOs and shareholders of the lending companies would get rich.

So as the housing bubble has started to collapse, so has Fannie Mae’s stock price. (Check the 1 year or 5 year graph.) Freddie Mac’s stock price has been just as ugly.

Now, as already mentioned, Fannie Mae is (strictly speaking) a private corporation. However, over the years they have bent the rules and implied that the US government backs their loans. It wasn’t true, but by lending unwisely they’ve become so big that the government now thinks it can’t afford to let them fail. So last weekend, the the Treasury Department and Federal Reserve announced that they would make funds available as necessary to keep Fannie Mae and Freddy Mac solvent.

In other words, last weekend the US government effectively added up to $5.3 trillion to the national debt, which is an increase of 50%.

So ironically, by a year or two ago the situation had become so dire that IndyMac and ResMae found themselves with names that had negative connotations. ResMae collapsed last year, and now IndyMac has collapsed.

Now, in the event of a US bank’s collapse, individual consumers are protected by the Federal Deposit Insurance Corporation or FDIC. Basically, the government guarantees your money won’t disappear if the bank collapses, up to a limit of $100,000 per person.

Unfortunately, the FDIC doesn’t actually have enough money to bail out all the banks that are expected to crash. In fact, before IndyMac crashed they had funds to cover just 1.19% of the total insured deposits. After IndyMac, they dropped below the legal mandatory minimum of 1.15% coverage.

Theoretically, the FDIC gets its money by charging premiums to banks who wish to assure investors that they are FDIC guaranteed. So the problem of bailing out the FDIC will be passed on to the average taxpayer, in the form of higher bank fees. And if that fails, the taxpayer will be forced to bail out FDIC directly.

Some analysts are now comparing the fiasco to ENRON. Except this time, it’s an ENRON where the taxpayer has to bail out the crooks. So, another great victory for reduced government regulation and the free market.

Update:

On 2008-09-08, the US government formally took FNMA and FHLMC into public ownership making the bailout official. While not every loan is going to be defaulted on, the taxpayer is potentially on the hook for the entire amount; it’s on the balance sheet as a liability.

So, 5 undersea cables have now mysteriously been severed. Iran’s telecommunications connectivity is almost destroyed. Why on earth is this happening?

Meanwhile, Iran was due to start an international oil trading organization by February 11th, which would allow oil to be traded in currencies other than US dollars.

You know who else started selling oil in currencies other than the US dollar? Iraq, in 2000.

Hmm, what a coincidence.

In case anyone’s missing the significance: the only thing propping up the value of the dollar is that everyone needs oil, and you need dollars to buy oil. If countries could buy all their oil in (say) Euros, they’d stop dealing in dollars, stop lending the US money to run the deficit, and make it impossible to run the US economy as it’s currently being run. Or as the Economist puts it:

A shift towards a looser peg in the GCC would undoubtedly hurt the greenback. At the very least, dollars would be purchased at a slower rate—leading to what Mr Lyons calls “passive diversification”. At worst, the policy might encourage others to follow, sparking panic sales of American assets.

i.e. a very real chance of the US economy entering another Great Depression.

The mainstream media coverage of the US subprime mortgage meltdown has mostly been about all the folk who have lost their homes, and various plans the government has come up with to try and ease the problem. Thinking about it more carefully, though, doesn’t it seem a little odd for the US government to interfere in the sacred free market merely in order to save a bunch of poor people from ruin?

Well, the SF Chronicle has an interesting article that explains this curious situation. It’s not about saving people from losing their houses, it’s about saving the banks.

During the housing bubble which was fueled by the subprime lending, banks sold mortgage-backed securities. For those who don’t know, mortgage-backed securities are basically in-place mortgage agreements, packaged for resell between financial organizations, or between financial organizations and investors.

The key is to view a mortgage in the abstract, as a promise by person A to pay an amount X for N years. That promise has a value, and can be sold.

For example, we arranged our mortgage through a small financial firm in the Austin area. Once all the paperwork was done, they packaged us up as an asset and sold us to GMAC. GMAC took on the business of extracting money from us over the course of years, and paid the small financial firm a lesser amount in compensation for the value of us as a customer.

This is generally a good thing. Because GMAC does administration for millions of mortgages, they can provide convenient billing and payment services, and reduce per-customer overheads. For the small firm, the benefit was immediate cashflow and no ongoing overheads.

A similar process can be used to package a mortgage and sell it to investors as a bond. The bank gets to remove the liability from their balance sheet; they can then use the cash to provide mortgage funds to more homebuyers. Hence, allowing the transfer of mortgages as mortgage-backed bonds should allow more people to buy their own houses.

For example, suppose John Smith owes the bank $1000 a month for the next 20 years. That’s a total of $1,040,000. The bank could sell that mortgage to an investor as a bond for (say) $750,000. The bank would get the $750,000 immediately, reducing their liabilities. They could use the money to finance some new homebuyer’s mortgage. Meanwhile, the investor would get $1,040,000 over the course of the next 20 years, making a nice profit. And the whole thing could be treated like a regular bond or stock market investment–the bank could continue to process the collection of the actual mortgage payments, just like it would process dividends on a mutual fund investment.

The problem is that since the banks expected to sell off the mortgages to eager investors hoping to cash in on the property boom, they didn’t really care too much about checking that the mortgages were sound; and the investors didn’t really have any way to check on the actual person paying the mortgage.

However, there’s language written into these mortgage transfer securities stating that if there’s fraud, the bank which sold the mortgage is legally obligated to offer to buy it back at the original price–which is now often ten times the actual value likely to be extractable from the homeowner. Fraud like, say, people lying on their mortgage applications, or inflated property appraisals, or e-mails on bank computers suggesting that they knew the market was a bubble that couldn’t last. Then there’s the issue of companies like S&P, who helped the banks to structure the subprime mortgage securities to look as good as possible on paper.

So if too many mortgages fail, and investors start demanding that their junk bonds be repurchased by the selling banks, those banks will go under. At that point, the FDIC and the government will have to step in, and we’ll basically have a taxpayer-funded bailout of a bunch of big corporate banks who defrauded investors. It’ll be the Savings and Loan crisis all over again.

How about pressuring the investors not to call in the cops? Well, unfortunately a lot of the investors are in foreign countries. Some of them are foreign countries. With the current state of US diplomacy, a conversation that starts with “Hey, we were wondering if you could eat a few billion dollars in losses to fraud so that we don’t have to bail out our rich corporate buddies in full public view” might not go too well.

But never mind, it may not come to that. A crack team of financial experts are trying to come up with a way to salvage the situation. We know they’re experts because, as the Chronicle points out, they’re exactly the people who got us into the mess in the first place…

Crystal posts a link to a Boston Globe story about property prices in Massachusetts.

Houses here cost so much because there are too few of them for all the people who have been drawn to Boston because it’s such a great place for great minds to do great things. But that reputation, which has kept Boston competitive all these years, is beginning to buckle under the weight of absurd home prices. Even in a recession, Boston’s world-renowned hospitals, higher-education institutions, and biotech firms admit they are seeing their job offers turned down like never before, largely because of housing costs.

[...]

The Census Bureau says Cambridge is the city with the highest percentage of $1-million- plus single-family homes in the country. But this is a surprisingly recent phenomenon. Beaty has to go back only as far as 1986 to find Cambridge’s first million-dollar sale.

It’s the beginning of the end for Davis Square. Diesel only just survived being priced out, and there now appear to be two swanky upscale cocktail bars opening at once, each complete with chic frosted glass windows and ultra-modern designer furniture.

Meanwhile in Harvard Square, it’s so bad that the clothing chain stores like Abercrombie and Fitch are being priced out and replaced by boutiques selling Swiss watches.

An insightful comment from Robert Blatman, an obstetrician quoted in the Globe article:

“The crazy thing is, if I can’t afford to live in these areas, what about the teachers and the firemen? It really worries me that, at some point, this has to erode the quality of life that made the real estate around here so desirable in the first place.”

And that’s the problem. It’s not sustainable. As people making normal wages leave the state (10,000 a year on average), their homes go to developers and owner-speculators, not to another normal family. Ordinary businesses can’t get staff, because the only people within an hour’s commute who can survive on normal wages are the few still living with their parents. Which, in turn, means that everything from groceries to medical bills to utility bills gets jacked up 40% or more to compensate for the increased overheads.

So sooner or later, people start to look at their crummy 2 bedroom rented apartment with the rattling windows and chronic dust bunny infestation, and look at their bills, and then look at other parts of the country…and that’s why we’re leaving. Even if we had a million bucks, we wouldn’t be spending it to get a 2 bedroom house here. Cambridge is nice, but it’s not that nice.

Furthermore, it’s plain that the local powers-that-be aren’t going to do anything about the problem. If they’re lucky, the Boston metro area will turn into another Manhattan. If they’re unlucky, there will be a big crash. I don’t want to be around for either of those scenarios.

The Bush “stimulus” plan includes big tax breaks for people buying SUVs. Yes, you can get an SUV tax free, so long as it weighs over 3 tons [corrected]; dealers report businessmen buying luxury SUVs on their accountants’ advice.

Bankrupcy chain reactions continue, with some areas reporting a 40%+ increase in Chapter 11 filings year to year.

Apparently it takes about two years of denial before property owners accept that their house isn’t worth what they paid for it, so I guess we have a while to wait for affordable houses in Boston.

As you may have heard, there has been a modest rise of a few percent in consumer spending so far this year, leading to hopes that consumer spending will get the US out of recession.

As you may not have heard so loudly, the US trade deficit leapt up 15% in January, said to be fueled mostly by the fact that consumer spending is mostly on foreign goods.