Fannie, Freddie Model Declared Dead - FINALLY!

[Bryan Hancock]

So it appears that the GSE model is officially being declared dead by the Obama administration and is nearing major reform from what I am reading from a number of sources. Any thoughts on what this means for us going forward?

Higher rates and lower amortization periods? Higher down payments? More renters? Popular real estate techniques no longer working?

[Paul B.]

I don't think the issue is securitization, per se.

The issue is partly that an entity backed by the full faith and credit of the government -- oops, I mean the taxpayer -- undertook a social mission to increase homeownership. Whether you think that's a battle that should be waged by government in the first place is largely an opinion; we need homeowners, for sure, but we need renters, too. And at least as recently as 30 to 40 years ago, owning a home was something you aspired to.

You scrimped and you saved, and you dreamed of your white picket fence. My parents did this for six years, eventually putting 20% down on their home and taking out a fully-amortizing 10-year loan -- at a rate of 10.75%, I believe.

Of late, however, the notion is that you need only 3% down to buy a house, and hey, if you don't have that, get a relative to give it to you, or get a non-profit to help you, or hey, just pay 3% more for the house and get the seller to contribute 3% (or more). We've had people buying houses for years with no real skin in the game, and for a time, it all worked out. They were able to make their payments, and eventually the home's value crept up enough that, even if there was a foreclosure, the lender had a better shot of coming out whole. (Everyone remembers the 125% LTV HELOC, right?)

My point in all of this is that it has little to do with securitization, which is nothing more than taking a basket of small securities (the individual loans), putting them into a larger basket, slicing that basket up into pieces with some degree of cash-flow predictability. Now, did Fannie and Freddie rely on this process to fund the loans they bought? Yes, of course. But securitization, in and of itself, is not the issue. At least in my opinion...

I think what we had here was the perfect storm. Not only did we have underwriting standards go out the window, but we also had interest rates held down too low after 9/11. The low rates did what they were supposed to do, which was keep the economy going, but they were kept there for far too long, and speculation in real estate was rampant. I think I remember there being a time when something like 40% to 50% of all real estate sales were "second homes" because people were buying solely for an appreciation play. Remember hearing tales of people buying two ocean condos, watching them double, then selling one to pay for both? I remember that very well...that was insanity.

So, we had a good ol' fashioned speculative bubble, only it was funded with debt secured by the very asset on which the speculation was being made, which made it even worse when the whole thing imploded. Sort of like when we used to let people buy stock on 90% margin...only with real estate we were really letting people buy it on 99% to 100% margin. Who WOULDN'T speculate on a house when you have zero dollars invested? Heads, I win...tails, you (the taxpayer) lose...

Time to conclude my rant...I suppose you could argue that, but for the securitization process, Fannie and Freddie never would have existed, ergo, securitization is to blame. If Fannie and Freddie were not GSEs, though, they could still have used securitization to raise funds for their operations, but the cost would have been a little higher because of the lack of the implied government backing. But, non-GSE versions of Fannie and Freddie would have likely paid more attention to credit quality (assuming that they could be brought down and not deemed "too big to fail"), and they certainly would not have had a social mission at the direction of the federal government.

I do agree that it would be better for everyone if the people who made mortgage loans just kept them in their portfolio, but the total value of all mortgages in the US (at least around 2008) was about $10 trillion. All banks in the US today have assets of about $12 trillion, so it looks as if we can't rely on the banking system to fully fund all of the country's mortgage needs, thereby making some level of securitization a necessity.