There have been so many housing and mortgage proposals and counterproposals
released in the past few weeks that it has been hard to keep up. It doesn't help that I've been busy in my day job, or that the wife needed to get a wisdom tooth pulled (In other words, I've been pressed into nursing duty!)
But I'm going to try to get caught up now, and share my thoughts on the latest developments ...
Let me start by saying that today's Wall Street Journal pretty much sums up the state of the housing and mortgage markets.
One key headline
: "Fannie Mae Tightens Rules for Mortgages"
: "Senate’s Housing Gridlock Eases"
The first story talks about the latest goings-on at Fannie Mae. The upshot of the story:
Fannie Mae is now establishing a minimum required credit score of 580 for most loans it will buy. It’s also reducing loan-to-value ratios for some types of mortgages. And it’s extending the post-foreclosure credit rebuilding period that borrowers have to go through before their loans are eligible for Fannie Mae purchase to five years from four.
In other words, Fannie Mae is making moves that have the effect of tightening lending standards — and it’s not alone. Several banks have cut back on the wholesale loan programs they offer through brokers. Meanwhile, Wachovia
considering an end to option ARM lending in parts of California.
The second Journal story points out that Congress is closer to passing a mortgage relief bill, despite intellectual and philosophical differences among Congressional Republicans, their Democratic counterparts, and the executive branch.
Put simply: The battle royale
between deflationary market forces in housing and government intervention continues to rage ... and intensify. So what exactly are the latest salvos in this ongoing fight? Here's my CliffsNotes
version ...Salvo #1: Consolidating the "Alphabet Soup" of regulatory agencies
— Treasury Secretary Henry Paulson introduced a mega-plan
earlier this week called the "Blueprint for a Modernized Financial Regulatory Structure." Right now, different parts of the financial markets and different types of financial institutions are regulated by an alphabet soup of government agencies.
The Commodity Futures Trading Commission (CFTC
). The Securities and Exchange Commission (SEC). The Office of Thrift Supervision (OTS
). The Federal Reserve. The list goes on and on. And for industries like insurance, supervision and regulation is essentially in the hands of the states, with little to no federal oversight at all.
The focus of the regulatory plan is to sort this whole mess out by consolidating agencies and responsibilities. In Paulson
"Intermediate-term recommendations focus on eliminating some of the duplication in our existing regulatory system, but more importantly they offer ways to modernize the regulatory structure for certain financial services sectors, within the current framework. Recommendations include eliminating the thrift charter, creating an optional federal charter for insurance and unifying oversight for futures and securities
"The long-term recommendation is to create an entirely new regulatory structure using an objectives-based approach for optimal regulation. The structure will consist of a market stability regulator, a prudential regulator and a business conduct regulator with a focus on consumer protection."
This stuff is great for debating around the campfire. But it doesn
’t look like many of these reforms will be instituted any time soon
. Longer term, some heads will undoubtedly have to roll for what happened during the bubble days — and this blueprint could provide some guidance on where the axe will fall.Salvo #2: FHA reform/foreclosure prevention programs —
Of all the mortgage reform programs being discussed, one in particular
is gathering momentum in Congress. It’s a bill that would potentially:
* Boost by $10 billion the amount of bonds that states can sell to fund mortgage refinance programs. They’re designed to get people out of bad subprime
loans and into more stable financing.
* Fund $200 million more in counseling programs designed to help borrowers facing foreclosure
* Give home builders a tax incentive that allows them to offset past profits with current losses in order to bolster their financial state
* Offer buyers of foreclosed or vacant homes a tax credit, possibly as much as $15,000
Meanwhile, a plan
from House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Christopher Dodd
may be gaining broader acceptance
. They envision a program where the outstanding loan balances of borrowers would be written down. This would ensure the existing lenders book some losses.
Then the borrowers would be refinanced into loans insured by the Federal Housing Administration, or FHA. Those loans would have smaller monthly payments because less principal would be owed. Borrowers would also be encouraged to stay put and try to pay off their homes, rather than walk away, because they would no longer be left "upside down" — owing more than their homes are worth.
But the borrowers wouldn
’t get a free lunch. They would be required to offer the government "soft second" liens on their properties. What that means is the government would get a portion of its money back upon the sale of the homes down the road. The presumption is that by then, home prices will have gone back up and everyone will "win."
To make it all work, FHA would be granted the ability to fund an extra $300 billion in mortgages.Salvo #3: Making the Fed a "Supercop"
— A more troubling move underway in Washington is to make the Fed even more of a market "Supercop
" than it has been acting like already. As the Wall Street Journal noted a few days ago:
"The Fed would retain, for now, authority to write consumer-protection rules on things such as credit-card disclosures and the terms of high-cost mortgages — despite accusations from consumer groups and Democrats that its failure to do so allowed many homeowners to get subprime
mortgages they couldn
"In Mr. Paulson
’s ‘optimal’ scenario, the Fed eventually would surrender its supervision of state-chartered banks and bank-holding companies to the new agency and become a ‘market stability regulator. The Fed, Mr. Paulson
said in an interview Saturday, ‘would have broad powers so they could go anywhere in the system they needed to go to preserve that authority.’
"In that role, it would be able to lend to any important institution while seeking information from them, which Mr. Paulson
considers more reflective of a financial system spread among brokerages and other nonbanks
as well as traditional, commercial banks."So in my humble opinion, what’s good, what’s bad, and what’s ugly in all of this?
First off, the policy of the Fed over the past several years has been to take a "hands off" approach to asset bubbles and regulation during the boom times. I've talked about the problems of this in detail
before. But to quickly recap:
There was no move to raise margin requirements during the tech stock bubble. And as the housing bubble expanded, Fed policymakers spent more time questioning
the very existence of a bubble rather than aggressively lambasting lenders and speculators for helping inflate it. They didn
’t sharply jack up interest rates to calm things down, either. Instead, they used measured, clearly telegraphed, 25-point hikes over a span of several quarters.
On the regulatory side of the ledger, the Fed and the other key agencies issued a bunch of "guidances
" on high-risk lending. But they had no teeth and essentially no on-the-ground impact.
But now that things have gone to you-know-what in a hand basket
, it’s suddenly time for an "all hands on deck" approach. The Fed is slashing interest rates dramatically, and throwing huge helpings of money at some of the very same companies and individuals that helped cause the mess in the first place. And all those high-minded principles we’ve
been hearing about — you know, like Larry Kudlow
’s favorite slogan: "Free market capitalism is the best path to prosperity?" They get thrown out the window in the interest of expediency.
Heaven forbid someone raises his hand in objection to some of the ideas being thrown around, either. Those folks get labeled as "Herbert Hoover" wannabes. Or worse, they’re told that they sound like Hoover’s Treasury Secretary Andrew Mellon
. He believed a hands-off approach to the stock market crash and the subsequent recession was appropriate, and was famously quoted as saying "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate" in order to "purge the rottenness" in the system.
Instead, we are told to just all rally behind the Fed — let it pull every lever and bend (or break) every rule to save the world. Or in simple terms: "The ends justify the means. Stocks can’t be allowed to suffer a short-term crash. Recession must be avoided at all costs. Get over it."
Look, I am NOT averse to offering targeted aid to deserving borrowers. I have talked about some of the ideas that make sense to me before. I’m pleased to see that despite all the pressure coming to bear on them, Fannie Mae and Freddie Mac actually seem to be keeping standards relatively tight ... and even tightening them ... to reflect the very real risk of further price declines. And the Frank/Dodd
proposals make sense in many ways. That’s because they would require lenders to take some losses, while also making borrowers who receive help pay FHA back for that aid by surrendering a chunk of any future appreciation.
But let’s stop and take a deep breath here about some of these other steps. Maybe, just maybe, Wall Street is getting its just desserts for throwing an easy money bacchanalia the past few years. Maybe, just maybe, we should allow the bad debts to be purged and yes, allow the firms that took on the most risk to suffer the worst consequences.
clearly does not agree. He had this
to say today about the Fed's dramatic intervention to save Bear Stearns
"On March 13, Bear Stearns
advised the Federal Reserve and other government agencies that its liquidity position had significantly deteriorated and that it would have to file for Chapter 11 bankruptcy the next day unless alternative sources of funds became available. This news raised difficult questions of public policy. Normally, the market sorts out which companies survive and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one company. Our financial system is extremely complex and interconnected, and Bear Stearns
participated extensively in a range of critical markets. With financial conditions fragile, the sudden failure of Bear Stearns
likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence. The company’s failure could also have cast doubt on the financial positions of some of Bear Stearns
’ thousands of counterparties
and perhaps of companies with similar businesses. Given the current exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns
could have been severe and extremely difficult to contain. Moreover, the adverse effects would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability. To prevent a disorderly failure of Bear Stearns
and the unpredictable but likely severe consequences of such a failure for market functioning and the broader economy, the Federal Reserve, in close consultation with the Treasury Department, agreed to provide funding to Bear Stearns
Chase. Over the following weekend, JPMorgan
Chase agreed to purchase Bear Stearns
and assumed Bear’s financial obligations."
I look at it this way: Would we have seen a 1,000-point down day in the Dow if the Fed hadn
’t arranged a shotgun wedding for Bear Stearns
over that fateful weekend? Maybe. But you know what? Maybe that would have been just the cleansing we needed to flush out the last of the $%^# and get on with a healthy, rebuilding process. At the very least, a good flush would have created some real bargains for investors who have acted prudently in the past several months, who didn
’t load themselves up with vulnerable financial stocks, and who were sitting on hefty cash levels.
And let me ask a few somewhat-out-of-left-field questions: If Bear Stearns
was truly "too big to fail," then how in the heck was it allowed to get that way
? Where were the regulators? Why did they allow it to build up so much counterparty
risk, or so much trading risk, or any other kind of risk that a failure could allegedly bring about the end of Western civilization as we know it? Why are any institutions
allowed to get too big to fail, for that matter? Shouldn't we pass some kind of law tomorrow that says "Any institution above $XX billion in assets now needs to be split up so that we never, ever end up with another TBTF
firm bailout?" That idea has a roughly 0% chance of ever coming to fruition. But I couldn't help but throw it out there.
In short, I have real reservations about the longer term impact of many of the things being done today ...For starters
, the Fed has done a poor job of preventing and fixing bubbles over the past several years. It failed to recognize and/or tame the dot-com bubble in advance. Then it reacted to the bursting of that bubble in such an aggressive manner that it created an even bigger bubble in housing.
Despite that track record, some are now considering deputizing the Fed as a financial markets Supercop
? Am I the only one who thinks there’s something wrong here?Second
, there’s the whole moral hazard risk of this Bear Stearns
transaction. The term refers to the risk that bailouts just embolden people to take even bigger risks down the road, knowing the Fed will save their bacon if they get into trouble.
Critics say there’s just no time for this kind of argument. Their view: Desperate times call for desperate measures. But let me ask you a question: Has each successive crisis that the Fed has tried to paper over (Orange County, Long-Term Capital Management, the dot-com bust, and so on) been bigger or smaller than the one before it? I think the answer is clear: Bigger. And I think one -- though certainly not the only -- reason for that is clear: Investors know that the Fed ultimately "has their backs."Third
, we have to consider the law of unintended consequences. Did the Fed mean to create a housing bubble to replace the dot-com bubble? I doubt it. Policymakers probably thought they were doing the legitimate, proper thing to cushion the economy from the impact of the dot-com bust.
But the reality is that while the Fed can CREATE excess liquidity and cut interest rates, it can’t CHANNEL that liquidity to specific markets. So we seem to be caught in this "rolling bubble" trap, where the "cure" for the popping of one asset bubble ends up creating a fresh asset bubble "disease" somewhere else.
The bottom line: Policymakers need to carefully consider the details of any and all bailout plans — and the long-term consequences of their actions. It’s not "Mellon-esque
" to let economic nature run its course, to the furthest possible extent. That’s what capitalism is supposed to be all about, right?
Phew. Sorry it took a while, but I had to gather my thoughts before unloading.