The Federal National Mortgage Association, or Fannie Mae, is a government sponsored enterprise that is authorized to make loans and loan guarantees. The company is not funded by the U.S. government, but the capital markets routinely treat the company as if the government has an understood obligation to back the company in the event of disaster.
Fannie Mae is critical to the secondary mortgage market which helps to replenish the supply of lendable money for mortgages and ensures that money continues to be available for new home purchases. Because of the federal government's substantial political interest in home ownership, the company is quite likely to benefit from government support if the business somehow collapses.
As a result of its special status, Fannie Mae has looser restrictions than normal financial institutions. Following the subprime mortgage crisis, its ability to sell mortgage-backed securities with half the capital backing them up than is required by other financial institutions has come into question.
The company ran aground in late 2006 when regulators filed charges against the chief executive and his key aides for manipulating financial statements in order to inflate their personal bonuses. The corporate culture cannot be excised overnight, but the underlying company is still quite the thoroughbred.
Showing posts with label Subprime Mortgage Woes. Show all posts
Showing posts with label Subprime Mortgage Woes. Show all posts
Tuesday, June 26, 2007
Tuesday, June 5, 2007
Eight Reasons Not to Worry about the Subprime Mortgage Crisis
1) The government will bail out the industry.
2) Subprime loans aren’t big enough to drag down the economy.
3) Experts like Greenspan are only exaggerating – only 2 years ago he said nothing was wrong. His media grand-standing is because he is jealous of the attention now paid to the new Fed chair Ben Bernanke who isn’t worried about subprime.
4) Any decline in housing prices just makes homes more affordable for the middle class. A declining real estate market represents a wealth transfer from rich people who own mortgages to the middle class who can now afford a home.
5) Any downside risk is completely mitigated by the real value of housing. This can’t be a repeat of the Dot Com Bust because real assets back up the loans.
6) Predatory lenders are the ones suffering. The moral good of punishing those who take advantage of the poor and financially illiterate outweighs financial loss.
7) Companies like New Century Financial have committed crimes and won’t survive under any circumstances – and that’s a good thing.
8) Falling housing prices will encourage the Fed to lower interest rates and drive broader economic growth.
2) Subprime loans aren’t big enough to drag down the economy.
3) Experts like Greenspan are only exaggerating – only 2 years ago he said nothing was wrong. His media grand-standing is because he is jealous of the attention now paid to the new Fed chair Ben Bernanke who isn’t worried about subprime.
4) Any decline in housing prices just makes homes more affordable for the middle class. A declining real estate market represents a wealth transfer from rich people who own mortgages to the middle class who can now afford a home.
5) Any downside risk is completely mitigated by the real value of housing. This can’t be a repeat of the Dot Com Bust because real assets back up the loans.
6) Predatory lenders are the ones suffering. The moral good of punishing those who take advantage of the poor and financially illiterate outweighs financial loss.
7) Companies like New Century Financial have committed crimes and won’t survive under any circumstances – and that’s a good thing.
8) Falling housing prices will encourage the Fed to lower interest rates and drive broader economic growth.
Subprime Mortgage Crisis
A subprime mortgage is any loan extended to someone with poor credit that allows them to buy a home in spite of their poor repayment history. In general, anyone with a credit score below 620 qualifies as subprime. These borrowers pay significantly higher rates of interest in order to compensate lenders for the increased risk they represent. When prevailing interest rates on home loans are 5-6%, subprime borrowers routinely pay in excess of 9%.
The problem with subprime mortgages is that when the economy weakens and people can’t afford to pay for their homes, subprime borrowers are the first and most frequent defaulters. It is important to remember that defaulting on a home mortgage is very rare. Historically, the post-Depression era has never witnessed default rates greater than 4%. Current default rates in the subprime market are in the neighborhood of 2%. While not high by historical standards, near the end of a decade-long run-up in real estate prices default rates fell to less than 1% just a few years ago. Lenders like HSBC and New Century Financial made billions of dollars at the height of the boom extending loans to almost anyone who wanted one. Now that the real estate market has weakened, these over-aggressive lenders are losing their shirts. New Century Financial in particular has exacerbated its troubles through Enron-esque accounting gimmicks and is now the subject of an SEC investigation and numerous shareholder lawsuits in connection with its collapsed stock price.
Because of the size of the real estate market, easily measured in trillions of dollars, the current subprime mortgage implosion has cost big lenders an enormous amount of money. However, home mortgages are generally one of the most secure loans that banks can make. Even if the borrower defaults, banks can foreclose on the home and generally collects about 75% of the value of the loan by selling the house. Also, subprime mortgages represent a tiny part of the total mortgage market. When 15% of the mortgage market is subprime and only 2% of these risky loans are defaulting, it is clear that most homeowners and their banks will be just fine.
Many prominent economists have claimed that they see a great risk of spillover from the subprime mortgage market into the economy at large. George Soros’ partner and former Fed chair Alan Greenspan have both indicated that the crisis could spread throughout the economy. Their rationale is that in a weakening economy, people will be particularly harmed by the declining value of their homes. Since the national savings rate is still negative, homeowners have been driving the retail economy by taking out lines of credit on their homes. As poorer people with subprime mortgages lose their homes and drive down the value of everyone’s real estate by flooding the market with houses at fire-sale prices, homeowners are much less capable of borrowing to drive consumer spending.
If things in the subprime mortgage market get worse, some prominent Democrats and Republicans from effected states are already talking about a government bailout along the lines of the S & L bailout. This is a particularly appealing model, not only because the government saved thousands of jobs immediately by buying into the Savings and Loans but also because it ultimately made money on the deal.
The problem with subprime mortgages is that when the economy weakens and people can’t afford to pay for their homes, subprime borrowers are the first and most frequent defaulters. It is important to remember that defaulting on a home mortgage is very rare. Historically, the post-Depression era has never witnessed default rates greater than 4%. Current default rates in the subprime market are in the neighborhood of 2%. While not high by historical standards, near the end of a decade-long run-up in real estate prices default rates fell to less than 1% just a few years ago. Lenders like HSBC and New Century Financial made billions of dollars at the height of the boom extending loans to almost anyone who wanted one. Now that the real estate market has weakened, these over-aggressive lenders are losing their shirts. New Century Financial in particular has exacerbated its troubles through Enron-esque accounting gimmicks and is now the subject of an SEC investigation and numerous shareholder lawsuits in connection with its collapsed stock price.
Because of the size of the real estate market, easily measured in trillions of dollars, the current subprime mortgage implosion has cost big lenders an enormous amount of money. However, home mortgages are generally one of the most secure loans that banks can make. Even if the borrower defaults, banks can foreclose on the home and generally collects about 75% of the value of the loan by selling the house. Also, subprime mortgages represent a tiny part of the total mortgage market. When 15% of the mortgage market is subprime and only 2% of these risky loans are defaulting, it is clear that most homeowners and their banks will be just fine.
Many prominent economists have claimed that they see a great risk of spillover from the subprime mortgage market into the economy at large. George Soros’ partner and former Fed chair Alan Greenspan have both indicated that the crisis could spread throughout the economy. Their rationale is that in a weakening economy, people will be particularly harmed by the declining value of their homes. Since the national savings rate is still negative, homeowners have been driving the retail economy by taking out lines of credit on their homes. As poorer people with subprime mortgages lose their homes and drive down the value of everyone’s real estate by flooding the market with houses at fire-sale prices, homeowners are much less capable of borrowing to drive consumer spending.
If things in the subprime mortgage market get worse, some prominent Democrats and Republicans from effected states are already talking about a government bailout along the lines of the S & L bailout. This is a particularly appealing model, not only because the government saved thousands of jobs immediately by buying into the Savings and Loans but also because it ultimately made money on the deal.
Thursday, May 17, 2007
Bernanke Sees No Subprime Mortgage Contagion
Reuters reports that Fed Chairman Ben Bernanke has come around to the conventional wisdom that the subprime mortgage woes that so captivated the media will not metastasize into a broader recession.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Sunday, April 29, 2007
US Economic Downturn Possible, but Improbable
Reuters reports that the President of San Francisco's Federal Reserve suggested that a downturn in the US that ripples around the world is possible. Of course, she qualified that statement to make it significantly less meaningful than the article suggests. Her analysis appears to consist of noting that the US represents 25% of world production and that the US economy hasn't been doing well recently. She goes on to say that her own opinion is that growth picks up instead of slowing into a recession, but that wouldn't make for exciting headlines.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Thursday, April 5, 2007
Detroit Collapsing - Sign of Broader Troubles or an Isolated Problem?
The IHT reports that Detroit is in serious economic trouble. The article starts with an anecdotal account of a man who can't sell his home that creates the false impression of a connection with the subprime mortgage debacle. Subprime mortgage woes are in the news, but this sort of shoddy journalism creates hysteria where it isn't warranted by the facts.
As the article goes on to note, Detroit led the nation in foreclosures last year because the auto industry put more than 350,000 people out of work in the state with the highest unemployment rate in the nation.
Things look bad in Michigan right now. Home prices have fallen more than 5 percent in the last three years, while the rest of the nation's real estate has been on a tear. And it's not just the little guy who is suffering. Ford is axing 30% of its executives as it struggles to compete with Toyota.
But it would be wrong to interpret things as too terrible. The reporter filing her assignment from Detroit plays up the risk of default by even prime mortgages. The facts don't really back her up. The percentage of prime loans overdue by 3 or more months is a tiny 0.67%.
It must be terribly difficult for an entire region of the country to go through such a gut-wrenching decline, but Detroit is managing about as well as could possibly be expected. If 350,000 people lost their jobs in almost any other industry, the impact would be much worse. The very same unions that the Big Three automakers blame for strangling their profit margins are ensuring that most workers are getting extremely generous buyouts. It's not even that uncommon for middle-aged autoworkers with few transferable skills to receive six-figure checks to compensate them for their lost jobs.
The situation in Detroit is tragic, but a system that is allowing frugal blue-collar workers to essentially retire in their early 50s is hardly sticking it to the working man. It must be hard to have to completely start over at such a late stage in life, but at least they aren't being tossed out in the street empty handed.
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