Today’s headline reads, “Bailout Cost of Fannie, Freddie Rises”. If you’re like me, you read that and think, “Like, news flash dude, they hold a boat load of lousy loans…” And you may also find yourself outraged by this. If you watch CNBC and listen to Larry Kudlow and the like, you may be thinking, “We should just let them go under. After all, isn’t that capitalism, the strong survive and the weak do not? Besides, those are my tax dollars and my money!” To this, I say, “Let me tell you a story…”
In August 2007 I had by chance, a meeting with Scott Abrams, campaign manager for California Congressman Brad Sherman, to discuss his speaking at a brunch I was putting on. During our meeting over breakfast, the financial collapse was playing out before our eyes and just being discussed on CNBC. It was sort of like watching the hole you just dug in the sand, fill up as the wave swept over the top… It was shocking and scary and very unnerving because it seemed to catch almost everyone off guard. I told Scott that morning, that it had been unfolding for a few weeks and if something wasn’t done quickly the entire housing market was going to fall off the edge of the earth. He asked me to explain. I said, “The banks can’t sell their loans and are running out of money to lend”. Scott was surprised by this. Banks run out of money? From my perspective, I could see that Wall Street had suddenly stopped purchasing packages of mortgages, from the big banks. As someone selling homes that required mortgages, the only loans my clients could find were from portfolio lenders, usually made up of former thrifts and savings and loans. (A portfolio lender doesn’t sell the note, but rather keeps it on their shelf; satisfied to earn interest rate return they lent the money at to the borrower. – think Capra’s “It’s a Wonderful Life”, and the Bailey Brothers Building and Loan…) The problem with this I explained, was that the vast majority of lenders did not hold the paper ad infinitum, but rather were satisfied making the 1% loan origination fee and getting the servicing contract (collecting the payment every month from the Wall Street investors who purchased the mortgages). By selling the loan and getting the money they had just lent back, the lender had a fresh pile of money to lend to someone else. This allowed them to lend and lend and lend. But once there were no longer buyers for those loans, the banks, I said, would run out of money and there would be no more transactions. Banks had to have a marketplace to sell the paper (called the secondary mortgage market), and that marketplace had effectively evaporated over night. I was particularly concerned about jumbo loans since at that time the conforming loan limit (loans Freddie and Fannie buy) was $417,000, and most of my clients needed to borrow far more money in our “inventory restricted” housing market. Our breakfast ended with Scott very puzzled and concerned and over the course of several months we exchanged emails as the enormity of the situation became clearer.
So what does this have to do with the Freddie Mac and Fannie Mae bailout costs rising? Basically, it costs what it costs and we just have to accept that. “No we don’t”, you might say; “Uh, yeah you do and you’re going to like it” say I. You see, without these two, now taxpayer owned behemoths buying mortgages, virtually no one would be able to buy or sell a piece of real estate in America. Why? Because the banks would have run out of money to lend long ago. Banks have to keep a certain amount of money in reserve – remember their money is really our deposits and they can’t lend it all in case we want to withdraw it. Freddie and Fannie are single handedly keeping the housing market going in the U.S. In places like China, there are a scant few housing loans and even with those, buyers can only borrow at 30-40% of the value, the rest is paid in cash. In fact most in China still pay 100% in cash for property. Can you imagine if that were the situation here? How would you ever be able to buy or sell a house?
That’s why I’m not worried by the headline and thank G-d that there is a Fannie and Freddie; that they raised their limits to $729,750 and that we continue to bail them out and ensure their solvency, because in doing so, we ensure our own solvency. Without them we really might be back to selling pencils on the street corner.
You’re right. Years ago, mortgage money came from the insurance companies. They had to invest somewhere, and what could be safer than real estate? Limited supply and increasing demand. We do it the same way, only putting a down payment and getting a loan for the rest. And the government lets me deduct the interest. Sure is better than paying rent.