Uncle Sam Blowing Fresh Air Into the Housing Balloon?

With housing prices down 30+% on average over the last few years, is Uncle Sam blowing fresh air into the housing balloon and actually creating another housing bubble? I believe that’s exactly what is happening.

If you are scratching your head and think I am off base with my assertion, please navigate this path along our economic landscape with me.

What drove the housing bubble? Cheap rates and undisciplined lending from the private sector. What added to the bubble? The internal ‘hedge fund’ portfolios of Freddie Mac (NYSE:FRE) and Fannie Mae (NYSE:FNM).

What is perpetuating the housing bubble if not creating another mini-bubble of sorts? Cheap rates and undisciplined lending directly from Uncle Sam or supported by Uncle Sam. What is adding to this bubble? Those same internal portfolios at Freddie and Fannie.

What entities within Uncle Sam’s domain are providing the cheap rates and undisciplined lending?

1. The Federal Housing Administration ( FHA-insured loans are packaged into GNMA securities, which have the explicit backing of Uncle Sam)

2. The Federal Reserve’s quantitative easing program in which it has purchased hundreds of billions in mortgage-backed securities with authority to purchase a total of $1 trillion+ in MBS is also blowing fresh air into the balloon.

3. Freddie and Fannie are also supporting the bubble by providing fresh capital via their portfolios.

People may say that Uncle Sam had to provide this capital because the private sector would not. In fact, The Wall Street Journal makes that very assertion this morning in writing, Industry Seeks Fannie, Freddie Overhaul:

Together with the Federal Housing Administration, Fannie and Freddie now purchase or guarantee nearly nine in 10 new mortgages, since private buyers of such loans have been absent amid the housing bust.

I categorically do not accept this assertion. There is more than enough private capital in the system to purchase these mortgages. The issue is that the private capital will only purchase these mortgages at appropriate risk adjusted prices. Freddie, Fannie, the FHA, and the Federal Reserve are stepping ‘through the market’ and subsidizing mortgage rates by at least 50 basis points and, in turn, crowding out private buyers. The WSJ continues:

Fannie and Freddie have taken nearly $96 billion of capital infusions from the U.S. Treasury since last November. The companies have received nearly 10 times that amount in additional support through purchases of debt and mortgage-backed securities by the Treasury and the Federal Reserve.

Who is benefiting from these subsidized rates? New homeowners. Do not think for a second, however, that risks are properly aligned in this current mortgage dynamic.

The continued mispricing of risk will mean our housing market will experience more protracted levels of delinquencies, defaults, and foreclosures than if mortgage rates were higher and real discipline were instituted into the lending process.

In fact, unless our country accepts a fully socialized mortgage finance system, mortgage rates will have to move higher to reflect private sector pricing. Risks and returns will then be properly aligned and the bubble will deflate.

Graph: WSJ

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

Visit: Sense On Cents

2 Comments on Uncle Sam Blowing Fresh Air Into the Housing Balloon?

  1. You are absolutely correct. They are packaging these mortgages as securities again, except this time they are claiming that the investors are aware of the “not so good” loans in the portfolios and that makes it ok to sell as AAA. More of the same. Combined with the commercial real estate collapse coming up, we are in for a devastation, but some how lots of ppl just don’t believe that can happen here. When the have nots no longer get their entitlements because there aren’t any, is when real criminal problems will escalate. As they are now. Even now with 0 interest rates and recession, prices should be dropping not continuing to rise. When interest rates rise, and they will; inflation will go through the roof!
    So sad the socailist gov in place can’t see it.
    Ron Paul should have won.

    • How can interest rates ever go up? Companies have their arms so far up Bernanke’s asset-backed paper programme that a twitch of the thumb and forefinger move his lips. Look at the money everyone’s coining as interest costs fall through the floor. And now Bernanke’s going to slam down his foot? No way. The U.S. government is now 100% leveraged to low rates. All of their insider trading (buying TARP warrants then flooding the banking system with free money to boost share prices) can’t form a single chair leg to support the carry trade that’s boosted metals and stocks and Chinese one-bedroom apartments ($850,000) to prices that reflect full employment and 5-7% GDP growth. Five years from now we’ll be talking about hearings to roast these free-money guys over political lava floes.

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