This week the Obama Administration plans to present a report to Congress to address Fannie Mae and Freddy Mac, the mortgage finance and guarantor companies the government seized two and a half years ago in an effort to stabilize the US housing market and save the nation's banking system. By all accounts--leaked widely in the press this morning--the crux of the report will be a variety proposals from spinning the entities back into the private sector to eliminating them altogether.
Perhaps nothing the administration does--from appointing Supreme Court justices to starting or ending US military commitments in the Middle East and elsewhere--will have a more important and lasting impact on American life, presuming that a end to government home mortgage support is even possible, fiscally or politically. For better and worse Fannie and Freddie--like a foreign object in the human body around which years of tissue have grown--are so intertwined with the American economy that surgically removing them without killing the patient will be a nearly impossible operation.
For one thing, it's almost impossible to understate the importance of mortgage lending to the US economy. We're talking about a $10.6 trillion chunk of cash, so even seemingly marginal changes, say, to the value of loans the entities guarantee to the amount of mortgage backed securities they own will send shockwaves through the economy as a whole. For another thing, since the economic meltdown, the two government sponsored enterprises have become even more crucial to the barely-breathing US housing market than before--today backing 90 percent of all new mortgage loans. As weak as the vital signs are for the US housing market, they are almost entirely dependent on Fannie and Freddie like a coma patient is dependent on a ventilator. Finally, and I know conservatives don't want to hear it, but Fannie and Freddie historically have actually done a better job managing risk and preventing the kind of bubble and crash we witnessed in recent years than private sector lenders and investors.
That last statement flies in the face of ideological and lobbyist-financed arguments Republicans on the Hill are likely to raise when they get their hands on the President's report this week. For the GOP it's an article of faith that government intervention in the housing market was the primary cause of the housing bubble of the 2000s. I'm not saying that government played no role. Far from it--undoubtedly though the government helped fuel the housing bubble through tax incentives and credits of the sort that created financial benefits for consumers to borrow money; it's also certainly true that the market presence of a government or quasi-government buyer of mortgages and mortgage-backed securities bends markets the government's way. But more than anything it was the boom in the securitization of mortgage debt, and the leveraged-lending feeding frenzy it touched off on Wall Street, as well and the privatized Fannie and Freddy's need to compete in that market, that played the biggest role in flooding the market with credit regardless of a borrower's risk.
Look at this chart published today by the Wall Street Journal:
It's far from coincidental that the real estate bubble years correspond to a flood of private cash--much of it borrowed--into mortgage backed securities. During the boom years, stable credit spreads attracted investors from hedge funds to ibanks into a mostly unregulated market in MBS's and derivative investments on top of them. Sustaining this paper churning, money making machinery required constantly feeding the furnace with new loans, preferably higher interest loans like those made to subprime borrowers.
The result was a sand castle housing market destined to crumble as uncreditworthy borrowers defaulted on mortgages, real estate values declined, and leveraged investors as well as consumer banks (who had been freed from preserving cash thanks to the "innovation" of off balance sheet accounting) found they had nowhere near the cash reserves they needed to cover their losses.
Two an a half years after the federal government first started to triage the wounded lenders and borrowers, the housing disaster is no better and trauma cases abound.
Writing last September in US News and World Report, Mort Zuckerman offered a tidier description than I can of the landscape then:
The economics of home ownership could hardly be more disastrously opposite to the expectations of generation after generation. Millions of homes have been foreclosed upon. About 11 million residential properties, or about 23 percent of such properties with mortgages, have mortgage balances that exceed the home's value. Given the total inventory, and the shadow inventory of empty homes, many experts expect prices to fall another 5 to 10 percent. That would bring the decline to 40 percent from peak-to-trough and expose an estimated 40 percent of homeowners to mortgages in excess of the value of their homes.
The growing risk of disappearing equity invites more strategic defaults on mortgages. Homeowners with negative equity are tempted simply to mail in their keys to their friendly lender even if they can afford the mortgage payment. Banks don't want to take the deflated properties onto their books because they will then have to declare a financial loss and still have to worry about maintaining the properties.
Little wonder foreclosure has not been enforced on a quarter of the people who haven't made a single mortgage payment in the last two years. A staggering 8 million home loans are in some state of delinquency, default, or foreclosure. Another 8 million homeowners are estimated to have mortgages representing 95 percent or more of the value of their homes, leaving them with 5 percent or less equity in their homes and thus vulnerable to further price declines. A huge percentage will never be able to catch up on their payment deficits.
The pace of foreclosures was briefly slowed by loan modifications brought on by government programs. Alas, the programs have not been working as hoped. Half of the borrowers have been redefaulting within 12 months, even after monthly payments were cut by as much as 50 percent. The foreclosure pipeline remains completely clogged. As it unclogs, a new wave of homes will come on the market and precipitate additional downward pressure on prices. The number of foreclosed homes put on the market by banks will be a more powerful influence on the further decline of home prices than either consumer demand or interest rates.
A well-balanced housing market has a supply of about five to six months. These days the supply is more than double that, as inventory backlog has surged to about a 12½ months'....
Things have only gotten worse since last fall with prices continuing to drop and foreclosures and delinquencies continuing to occur.
The economic price of this disaster is clear in the millions of foreclosed houses clogging the market, in the hundreds of millions of taxpayer dollars spent to bailout collapsed banking institution, in wipeout of asset values of American families. But the impact on the national psyche is more subtle. When you ask people do define "the American dream" many will evoke images of the home in the suburbs with two cars in the garage, three kids playing in a picket fenced yard. That's not what writer James Truslow Adams meant exactly when he coined the phrase in his 1931 book The Epic of America. Here's what Adams wrote:
...that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.
Class mobility, that's the American dream. And while its erosion has more to do with things like the loss of high-paying working class jobs, the decline of American primary education, and the crippling costs of college and graduate schools, it remains intimately tied to hearth and home as both asset--since purchasing a home will always be the most substantial investment most American families will ever make and therefore will always be crucial to class mobility--and as symbol--since our homes not only provide the roofs over our heads but also stand as a metaphor for our sense of community.
While many Americans' eyes may glaze over as talk begins in Washington of mortgage backed securities and long term mortgage rates, make no mistake, as much as anything lawmakers will be talking about the aspirations that bind us as a people. Pay attention.