Ezra Klein: More Deep Finance

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August 17, 2007

More Deep Finance

by Nicholas Beaudrot of electoral Math

The WSJ's political news blog has Chris Dodd (D-CT) criticizing the Bush administration for not letting Fannie Mae and Freddie Mac, the entities responsible for loan guarantees on a large number of mortgages, expand their portfolios to take on more mortgage debt to help provide some liquidity in the markets during the credit crunch. I saw Chuck Schumer (D-NY) make a similar complaint.

I really have no clue who's looking out for whom. Which side is doing the work of Big Finance? Is letting Fannie and Freddie take on more (riskier) debt a good idea? Help me, oh Lazyweb!

elsewhere, I note an analyst with Inside Mortgage Finance suggests that Countrywide is "too large to fail" and that our nominally pro-free market Republican administration would have to intervene to keep from failing due to its willingness to take on high risk mortgages. Market hysteria makes people say crazy things.

August 17, 2007 | Permalink

Comments

I've decided that the real investment strategy of hedge funds is to become "too large to fail." If you can get enough really wealthy investors and use enough leveraged investments that your collapse would bring down large parts of the economy, the government will back you up in the end. Effectively, you're backed by the US government. So you have the returns of a high yield investment but only the risk of a government bond- perfect investment vehicle, if you have enough money.

Posted by: SP | Aug 17, 2007 3:26:34 PM

As I understand it, the idea is to allow Freddie Mac and Fannie Mae to purchase loans over the current limit ($417,000 for a single-family home, I believe). The reasoning is that those loans have a much lower default rate than smaller loans, and in some markets you can't find homes in the price range they can cover. It would supposedly increase their solvency.

Posted by: Sanpete | Aug 17, 2007 3:52:24 PM

Here is a post from the vowel-less one

To Put or Not to Put

"Let me be more precise. There was, and is (and ever more shall be, if the Fed does its job well), a put on the general price level." ...knzn

Posted by: bob mcmanus | Aug 17, 2007 4:00:08 PM

It's the Larry Kudlow problem. Free markets are great until they, or their friends, lose their shirt. You have to remember, both Schumer and Dodd are great friends of the financial services industry. Look at their campaign contriburions!!

Posted by: Joe Klein's conscience | Aug 17, 2007 4:02:32 PM

Joe's conscience has it right. The question as to who works for big finance isn't a one or the other question, both republicans and democrats are guilty of enabling this mess and pushing industry interests over good policy. Fannie and Freddie can't fix the mess anyway as the mess is far too large, but I suppose raising the Jumbo limits can slow the coming pain for homeowners in high price areas.

Posted by: greg | Aug 17, 2007 4:36:04 PM

Sanpete is accurate in the thought process. People are unable to get jumbo loans (anything over Freddie and Fannies limit) even if they have no risk of default. They can't get the loans because the mortgage companies don't have any money to loan since the secondary market has gone solid.

It would definitely provide liquidity, but I don't know i f it would end up making much difference to the root cause of over leveraging and sub-prime shenanigans.

Posted by: crack | Aug 17, 2007 4:42:40 PM

There are still free market people who do not want intervention (that would be really wanting a free market to be free). Letting Fannie Mae and Freddie Mac into the jumbo loan market (loans over their current ceiling) would take pressure off people who have trouble securing jumbo loans - right now, many middle income home buyers are pushed into the jumbo loan market because home prices have risen so much (i.e. $417,000 was the ceiling because few people went over it). That's forced people to take both a first and second mortgage at time of purchase (the one up to 417 plus a second for the difference); that, as you might guess, is a recipe for defaulting.

The problem with all of this is that none of this is what Freddie Mac or Fannie Mae were originally created to do - they were meant to be support entities helping low income people buy homes. By distorting their missions, Freddie and Fannie are now holding a huge percentage of all the mortgages in the country, and they have been rife with management and waste issues. Dodd and Schumer's push to give Freddie and Fannie more involvement has as much to do with their power within the Democratic Party as it does with any high minded altruistic notion that their involvement will help (Schumer, remember, is also the Senator of Wall Street, literally, since it's in his state; Dodd, too, is Senator Insurance). People who really know these things question whether Fannie and Freddie moving into jumbo loans is really a good idea. I suspect that at this point there's not much choice, and in order to keep the mortgage market in any kind of reasonable shape they will have to have their ceilings raised. But I get the sense that unlike last week, this week has been a pretty serious wake up call to the severity of the mortgage problem and the potential havoc it will wreak on the economy; now the problem is that no one has a great answer about what to do about it.

Posted by: weboy | Aug 17, 2007 4:44:09 PM

Jumbo mortgages are not riskier in the sense that they default more often than conforming loans. As I understand it, they are riskier to the lending institutions because Fannie and Freddie do not buy them, so they have to be securitized and sold on the market, unless the bank has enough capital to keep them in their portfolio. Usually, the bank wants to sell them as securities so they can raise more money to lend. If they have to keep them they have to use money from other sources. The problem has been that lenders have not been able to sell those securities for the last couple weeks.
Anyone with good credit and enough earnings on paper can still get a jumbo mortgage, but the cost in fees for a good rate has increased substantially. Really, this only matters in markets like mine (San Diego) where the median home price is well into jumbo range.
As to stated-income high loan to value loans (which really got us into this mess), those are not being underwritten anywhere that I know of, given the volatility in the debt market. My employer has told us that those loan paramaters are not coming back.

Posted by: Sean | Aug 17, 2007 5:09:28 PM

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