Magazine asks, 'Do we really need Fannie and Freddie?'

Links of note: From the New Yorker via Patrick.net: The New Yorker's thoughtful economics essayist, James Surowiecki, observes that Fannie Mae and Freddie Mac "became reckless" with other people's money, notes they have little impact on mortgage rates and asks whether we really need them any more: "The government already offers homeowners a subsidy, in the form of a mortgage tax break. Given everything else we could be spending taxpayer money on, does the government really need to be in the mortgage-buying business, too?"

Freddie Mac, by the way, today reported a loss of $821 million in the second quarter, much worse than Wall Street expected.

Elsewhere, the Wall Street Journal goes where the L.A. Times went earlier in the week, profiling L.A.-based FirstFed Financial. As Mark Lacter writes at LA Biz Observed, "Both pieces, written in advance of earnings results this week, are mainly sympathetic to the company's big problem: how to handle the raft of pay option mortgages from a few years back."

Update on FirstFed: Those earnings (losings) are now out, and the company today reported a quarterly loss of $35.5 million, which Thomson Financial says is in line with analyst expectations.

--Peter Viles
Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com
Photo Credit: Bloomberg News

Comments

[Cal]

If I had a penny in FirstFed, either stock or savings account, I would have pulled my money after that WSJ article. The management is simply horrible.

The relevant part of the article:
"Babette Heimbuch, FirstFed's chief executive, says that option ARMs were "a very good loan for the borrower and the bank" for more than 20 years. But that changed, she said, when investment-banking firms entered the industry and set lower lending standards, which FirstFed and others followed.
...
At the same time, its existing borrowers refinanced into new loans at other banks that offered easier terms. "The fear was that at the rate loans were paying off we were going to have to close the company down," says FirstFed President James Giraldin.

Rather than shut its doors, FirstFed joined the crowd and business boomed."

And finally:
"In addition, many borrowers submitted loan applications that overstated their financial condition, making it more likely that they won't be able to afford even a modified loan. FirstFed figured that some borrowers had fudged their incomes and tried to protect itself with tighter credit standards. "But we were shocked by the magnitude of the lies," Ms. Heimbuch says. "You expect a 20% fudge. You don't expect 500%.""

I love how they present the issue as they simply just HAD to make these loans or else they would go out of business. There is simply no other way they could have possibly made any money other than a stated income option arm loan. The management saw how much others were making and the ability to book deferred interest as income and made a money grab. They weren't going out of business (thought hopefully they will now because of their stupidity) they just were greedy.

I also LOVE the stated income fudge factor they came up with. They knew and expected people to lie, they just underestimated how much they would lie... that was the problem with their underwriting... not that they were making stated income loans to begin with. It really is disgusting and I can't imagine anyone supporting management. The reporters really gave management the white glove treatment, though I think the WSJ did a far better job pointing out what a bad job they did. If had any money in savings there I would have pulled it out the morning that article came out. Because at the end of the day it is depositors supporting management.

[Bubblewatcher]

Per the New Yorker article:
"More important, if the last few years have taught us anything, it’s that homeownership is not an unalloyed economic good, and that we should be cautious about using gimmicks to make it more attractive. The government already offers homeowners a subsidy, in the form of a mortgage tax break."

I couldn't agree more. Unfortunately, the National Assoc. of Realtors is still the single biggest gov't lobbying group, so it's probably not gonna happen. But even as a homeowner taking full advantage of the mortgage interest deduction each year, I'd be the first to lobby on behalf of its elimination.

[bode]

Someone needs to watch "It's a wonderful life" again. In good times FRE and FNM don't affect interest rate -- they're low across the board, and risk is an afterthought (jumbo 5.5% mortgages, anyone? Bueller?). All you have to do is see how much business those two passed up -- they had to -- in 2005 and 2006, and how much they did in 2007, buckling in some degree to political pressure.

There's a great slide in FRE's deck today showing delinquencies over time, with a huge spike in mid-2007 and beyond. Not coincidentally, that's the start of the credit crunch, when the GSEs stepped in and did the job they were supposed to: provide liquidity when the bottom falls out and we teeter on a depression. I'm sure with BSC failing and the securitization of loans halted banks would have been falling over each other to take new mortgages onto their books in Q3 and 4 of 2007. Who needed FRE and FNM?

Whether or not they should be public or private is a fine discussion -- but the Great Depression pretty much proves the function is required. The article above doesn't really ask "do we need the function," it asks "do we need a private company to operate in the twilight zone?"

[Nick]

Respectfully, I think bode is mistaken. I don't think the function of the GSE's is to provide lower rate, riskier mortgages to people who would not otherwise be able to afford the house they are "buying", so that when they default the taxpayers can suck up the loss. If that's the stated goal of the GSE's, they are a horrible invention, and need to be dissolved immediately.

My understanding is that the stated goal of the GSE's is to provide liquidity in the mortgage market, preferably without setting or manipulating the mortgage rates and underwriting qualifications. Their job is to buy up the "very safe" loans, so that the banks are able to make as many of those safe loans as there are people who qualify for them wanting to buy houses. Basically, their existence is to make sure there's enough money in the system to give loans to the most qualified borrowers.

Their function fails when they are the only ones willing to underwrite certain types of loans, because then they are no longer providing liquidity for the "safe" segment, but rather gambling on the "risky" segment. At that point they're just risking public money to chase more profits, and their regulators are either asleep at the wheel, complacent in their actions, corrupt, or all of the above. That's what happened during the bubble, and it's still happening, and it's an absolute disgrace to the integrity of our country that it's still allowed to happen.