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Thursday, June 12, 2008


nationalizing the mortgage market

if anyone had suggested at the beginning of the term of the bush administration that, before it was out, we would see

... had you even suggested it, you'd have been laughed off the stage. anyone who took you seriously would probably be thinking along the lines of susan sarandon.

and yet.

yves smith highlights that the mortgage market has in fact become monopolized by the united states government. so much for free markets, indeed.

The US government has gone from being the biggest player in the mortgage market to being just about the only player. Per recent reports sent by an alert reader, Freddie Mac and Fannie Mae now finance 80% of all mortgages, and the FHA guarnatees another 10%, so these entities now come close to having mortgage finance all to themselves.

Having Fannie and Freddie, be this large, as we mentioned before, is disruptive to the credit markets. The GSE hedging of their derivatives book is pro-cyclical, increasing the amplitude of bond market price moves. Indeed, the Fed was worried that the scale of these operations in 2001, seeing possible systemic risk, but the restrictions imposes as a result of accounting scandals took care of that problem for a while.

distortive pricing is probably the least of the related concerns here. systemic risk, on the other hand -- or rather, the future probability that fannie, freddie and the FHA end up requiring government appropriations to survive -- is closer to the forefront. FHA, the government mortgage insurer, is already against its bounds. the FHLB system, which bore the brunt of govenrment lending to impaired banks in 2007, is exhausted. the federal reserve banks has since stepped into the FHLB's shoes and created lending facilities to take on significant credit risk itself and radically alter the composition of its balance sheet (though supposedly mitigated by the ultimate ability to put questionable securities back to the banks, failed banks take back nothing). fannie and freddie, despite the proclamations and intentions of govenrment, in the words of jonathan rosner, "in no position frankly to do much to save themselves let along save the market" -- something that will become painfully evident as defaults and foreclosures climb up the ladder to prime borrowers burning through their first, second and unsecured third HELOC mortgages. the capacity of weakened institutions such as these to truly support the $21tn mortgage debt market are likely, in the final analysis, to be trivial.

the probably result will simply be a roundabout taxpayer bailout of the entire mortgage mess -- something i've seen as necessary (though not sufficient) to put a floor beneath both housing and the banks. it's also something the government of japan has explicitly suggested.

and that may not be the end of the bailing. it's been noted that the fed now stands, in the aftermath of the bear steans bailout, squarely behind the credit default swap market.

the $64,000 question in all this is simply whether or not the dollar can withstand the sort of expansion of government debt that all this bailing implies -- and, if it will not, whether the federal reserve will not in fact be compelled to raise interest rates procyclically, with a depressing effect on the american economy.

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