(For previous parts in this series, scroll down and click on the links in the righthand column.)
The federal guarantee on mortgages was also a major factor in the housing bubble. Fannie and Freddie don't make loans. They are forbidden from doing so. Instead they buy mortgages from banks, bundle them into securities, and resell these to investors. This “securitizing” of mortgages doesn't require them to hold a mortgage on its books any longer than it takes to package and resell it. Once a mortgage is off the books, the agency's capital is freed up to do the same thing all over again. Hence the potential for a credit bubble. Even though the mortgages were sold to other investors, Fannie and Freddie for a fee still guaranteed that payments would be made on the loans. So when the banks—who got into the business pioneered by Fannie and Freddie—divided the securitized mortgages and repackaged them in SIVs (structured investment vehicles) and CDOs (collateralized debt obligations), the mortgage payments were still federally guaranteed. This made them attractive even to foreign governments and investors who didn't really understand these highly complex investments. All that mattered was the implicit safety that they were backed by the U.S. government. It didn't matter, as the Financial Crisis Inquiry Commission later pointed out, that Fannie and Freddie were twice as leveraged as Bear Stearns, a global investment bank that was an early casualty of the financial crisis.
Entirely separate from their function of buying mortgages from banks and reselling them with a federal guarantee, Fannie and Freddie also held mortgages and mortgage-backed securities for their own accounts. As of Febuary 2008, they each held a portfolio of more than $700 billion of these investments, which they could buy on the open market with borrowed money. Because of the federal guarantee, the GSEs were able to borrow (by issuing bonds) at very favorable rates. They made profits on the difference between their borrowing costs and the interest they received from the mortgages or mortgage-backed securities. Then they bought interest-rate swaps or other derivatives to ensure that the interest rate spread stayed positive. However, when interest rates fell, the derivatives declined sharply in value. For example, for the second quarter of 2010, Freddie Mac reported a loss of $4.7 billion with $3.8 billion of this coming from derivatives, due to low interest rates.
Federal policies also helped inflate the housing bubble in other ways. For example, the ability to claim tax deductions from interest on mortgages distorted housing prices. Because the tax deduction rises with the size of the loan, there was an impetus toward higher-priced homes and larger mortgages. The deductions “began effectively subsidizing gambles on fluctuations in housing prices,” says Dennis J. Ventry, Jr., an acting law professor at the University of California, Davis. States with the biggest mortgage interest deductions were among those hardest hit by the collapse. California ranked first in deductions, Nevada third and Florida eighth.
Another influential government factor was the Fed control of interest rates. Following the collapse of high-tech stocks (the “dot-com” bubble) in 2000, Alan Greenspan steadily brought interest rates down to 1 percent in June 2003 and kept them low for an extended period, fearing raising them too soon would be inflationary. This policy subsidized credit and stimulated home buying—and also home building in an already over-built industry—by helping to push the rates on long-term mortgages to the lowest levels since Freddie Mac began keeping track in the early 1970s. At the same time, it sent the banks looking for higher returns to mortgage bonds, which had not only attractive yields but the safety of AAA ratings and the government guarantee.
Lack of confidence in the dollar's historical ability to serve as a store of value, due to Fed monetary policies, also motivated people to purchase homes for this purpose. Within the experience of most people, homes appreciated while the dollar depreciated. People also turned to the stock market as an alternative store of value that would stay ahead of inflation, but that market proved too volatile to be fully satisfactory. Homes, however, were regarded as more stable, a “safe” investment and one likely to appreciate with what appeared to be an inevitable trend to inflation. That meant the prospect of paying off mortgages with depreciating dollars. Adding in the tax deduction for interest on mortgage payments, and home buying came to be viewed as virtually a “sure thing.”
On July 21, 2010 President Obama signed into law the most sweeping overhaul of the financial system since the Great Depression. At the signing of the bill, he claimed it provided “the strongest financial protection for consumers in the nation's history” and they would never again have to “foot the bill for Wall Street's mistakes.”[!] He said nothing about Fannie or Freddie. The 2,300 page law, which is longer than all previous financial regulations in U.S. history combined, doesn't cover them. It will require federal regulators to write hundreds of new—and costly—regulations that will apply only to banks and private financial institutions. Do you suppose omitting Fannie and Freddie from the new law had anything to do with the fact that as of 2008 they had almost 150 lobbyists and, according to Politico, spent almost $200 million on lobbying and campaign contributions in the previous decade? Federal Election Commission data shows the money went to 354 senators and congressman, with Senator Barrack Obama receiving the second most money, behind only Chris Dodd. As you may recall, Dodd was the Senate sponsor and a principal architect of the Dodd-Frank financial overhaul bill the President signed. The Center for Responsive Politics reports the peak year of Fannie and Freddie spending for lobbying was 2004, when it reached $26 million.
Yet in an April 2010 address, President Obama stated his financial regulatory proposals were struggling in the Senate because “the financial industry and its powerful lobby have opposed modest safeguards against the kinds of reckless risks and bad practices that led to this very crisis.” That is a statement of either flagrant dishonesty or flagrant ignorance.
I have written more extensively on the housing bubble in a 4-part essay “Mortgage Crisis, the Dollar and its Future” at link, which I recommend you read. But I have included some explanation of the housing debacle here because it relates to the unfolding situation of Greece's monetary crisis. It is far larger than the general public realizes, has not been “solved,” leaves the U.S. far more vulnerable to contagion from the Greek fallout, and has ramifications for the international monetary system in the future that few understand.
For Part VI of this series, click link
No comments:
Post a Comment