{"id":3496,"date":"2011-02-13T04:14:41","date_gmt":"2011-02-13T11:14:41","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=3496"},"modified":"2018-09-21T02:08:10","modified_gmt":"2018-09-21T06:08:10","slug":"the-world-post-fannie-mae-and-freddie-mac-part-two","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2011\/02\/13\/the-world-post-fannie-mae-and-freddie-mac-part-two\/","title":{"rendered":"The world post Fannie Mae and Freddie Mac, part two"},"content":{"rendered":"

In yesterday’s post I discussed the history and purposes of Fannie Mae and Freddie Mac, as well as the radical proposed changes to these two institutions as made by the administration of President Barack Obama.\u00a0 In today’s post I want to talk about the world post Fannie Mae and Freddie Mac.<\/span><\/p>\n

 <\/p>\n

Here are the overriding concerns associated with this potential sea change:<\/span><\/p>\n

 <\/p>\n

    \n
  1. Mortgage costs will increase for borrowers<\/span><\/li>\n
  2. The overall level of risk in the mortgage market will increase<\/span><\/li>\n
  3. Liquidity in the mortgage market will be diminished<\/span><\/li>\n
  4. Profitability at banks will change<\/span><\/li>\n
  5. There will be even more financial industry consolidation<\/span><\/li>\n
  6. Miscellaneous changes<\/span><\/li>\n<\/ol>\n

     <\/p>\n

    Mortgage Costs Will Increase for Borrowers<\/strong><\/span><\/p>\n

    I believe that one of the great myths associated with Fannie Mae and Freddie Mac is that they have somehow lowered borrowing costs for mortgagees.\u00a0 I think that supporters of the two government sponsored entities (GSEs) are using the wrong scale when evaluating the supposed benefit of Fannie and Freddie.<\/span><\/p>\n

     <\/p>\n

    Supporters have tended to focus on the individual borrower.\u00a0 Yes, it’s true that costs are lowered for the individual borrower.\u00a0 Yet, this observation ignores the proper context for evaluation.\u00a0 Namely, this belief ignores what the mortgage market looks like in its totality with Fannie and Freddie.<\/span><\/p>\n

     <\/p>\n

    If you look at the aggregate level of risk in the entire mortgage system, I think that Fannie and Freddie increase risks<\/em>.<\/span><\/p>\n

     <\/p>\n

    Mortgage rates increase as the riskiness of the borrower increases.\u00a0 Fannie and Freddie artificially lower the individual risk of a borrower by ostensibly agreeing to backstop the failure of a borrower to pay his\/her’s mortgage.\u00a0 That means that borrowers on the margin – those that would not have normally qualified for a mortgage – get home loans.\u00a0 So at the scale of the individual borrower rates are lowered.\u00a0 If you aggregate all of these borrowers, the thinking goes, rates have been lowered.<\/span><\/p>\n

     <\/p>\n

    However, what really happens is that the entire aggregate risk level of the mortgage system is increased.\u00a0 The reason is that there are many mortgagees who ought not to have home loans.\u00a0 After all, just because Fannie Mae and Freddie Mac have agreed to backstop these mortgages doesn’t mean that these borrowers have somehow become more financially responsible or solvent.<\/span><\/p>\n

     <\/p>\n

    Before intervention of Fannie and Freddie, underwriters were more careful with whom they underwrote for a home loan.\u00a0 That meant that mostly only folks who were financially able and ready got home loans.\u00a0 That meant the whole system was less risky.\u00a0 Less risk means lower mortgage rates.<\/span><\/p>\n

     <\/p>\n

    Once you have established a proper legal and regulatory framework for the functioning of markets, you then need a lack of price and risk distortions for those markets to truly work.\u00a0 Think about it.\u00a0 What happens when sellers have more information about a product than buyers?<\/span><\/p>\n

     <\/p>\n

    Think: the seller of a used car who knows that it needs transmission work.\u00a0 This is an informational and risk distortion.\u00a0 Enter CarFax.\u00a0 The risk to the system is lowered by information eliminating the distortion of a lack of information.<\/span><\/p>\n

     <\/p>\n

    Think: oil.\u00a0 Oil prices have been subsidized by the Federal Government for decades.\u00a0 How?\u00a0 By giving massive tax breaks to drillers of oil.\u00a0 That lowers the cost of production for these producers.\u00a0 Those lower costs are passed on to consumers – so gas prices are lower.\u00a0 But do these price distortions lower the risk that oil has on our overall quality of life?\u00a0 Do these price distortions lower the risks of global warming?\u00a0 Clearly not.<\/span><\/p>\n

     <\/p>\n

    Fannie Mae and Freddie Mac are price distorters of colossal size.\u00a0 They mask risks to the mortgage system.\u00a0 When those risks are revealed for what they are – like when the real estate bubble burst – the entire mortgage system collapses.\u00a0 Net: Fannie Mae and Freddie Mac do not lower borrowing costs when you use the proper scale for examining their impact.\u00a0 That scale is over the long-term and at the level of the entire system, not at the level of the individual borrower.<\/span><\/p>\n

     <\/p>\n

    The Overall Level of Risk in the Mortgage Market Will Increase.<\/strong><\/span><\/p>\n

     <\/p>\n

    It should be obvious from the points above that I think this is a ridiculous assertion.\u00a0 The greatest risk is price and risk distortions created by artificial subsidies that obscure an accurate assessment of risks, and especially of total risk.\u00a0 Therefore, the dissolution of Fannie Mae and Freddie Mac will lower the risk of the entire system.<\/span><\/p>\n

     <\/p>\n

    One of the ways this will happen is that lenders, unprotected by the largess of Fannie and Freddie, will have to be more careful at the outset when underwriting a loan.\u00a0 That will lower the overall risk level of the entire mortgage market, not increase it.<\/span><\/p>\n

     <\/p>\n

    One of the arguments for Fannie Mae and Freddie Mac is that they facilitate greater home ownership in the United States.\u00a0 So the concern is that sans the presence of the giant GSEs that somehow the level of home ownership in the U.S. will fall.\u00a0 Yet, as I pointed out yesterday, since 1968 when Fannie received the “full faith and credit of the United States” backing from the Federal Government, home ownership has only increased by 3.5%!\u00a0 That occurred during a time in which overall per capital gross domestic product (GDP) increased much more substantially.\u00a0 So this concern on the part of backers of Fannie and Freddie is not borne out by the statistics.<\/span><\/p>\n

     <\/p>\n

    Liquidity in the Mortgage Market Will be Diminished<\/strong><\/span><\/p>\n

     <\/p>\n

    Okay, now we are to a real concern.\u00a0 Fannie Mae and Freddie Mac, by creating a market for mortgage backed securities, have tremendously increased the liquidity in the mortgage market.\u00a0 Prior to the creation of these GSEs mortgages were a highly illiquid asset.\u00a0 After all, they were secured by an asset, a house, that was tough to sell relative to the nearly pure liquidity of a stock.<\/span><\/p>\n

     <\/p>\n

    If Fannie Mae and Freddie Mac go away there is no doubt that there will be fewer purchasers of mortgages and mortgage backed securities.\u00a0 However, my question is: and of what benefit is liquidity in the mortgage market?\u00a0 Isn’t okay if you cannot turn around and sell a mortgage?\u00a0 Well maybe.<\/span><\/p>\n

     <\/p>\n

    It is certainly nice if you are a bank that you can underwrite a mortgage, then have it bought by Fannie Mae and Freddie Mac.\u00a0 You take the cash handed over in that purchase and reinvest it in another mortgage.\u00a0 So profitability at banks will certainly be lower based on a reduced volume<\/em> of transactions.<\/span><\/p>\n

     <\/p>\n

    However, remember that the percentage ownership of houses in the United States has barely changed under the Fannie and Freddie regime.\u00a0 Isn’t it just as possible that sans the GSEs that the major commercial banks pick up the slack?\u00a0 Or that those very big banks fulfill a purpose similar to Fannie and Freddie in terms of creating a liquid mortgage market?<\/span><\/p>\n

     <\/p>\n

    Profitability at Banks Will Change<\/strong><\/span><\/p>\n

     <\/p>\n

    Notice that I didn’t say that profitability at banks will be reduced by lower volumes of mortgage transactions.\u00a0 I am not sure what will happen to the profitability of banks.\u00a0 There has been lots of speculation that if the liquidity provided by Fannie and Freddie disappears that transaction volumes for mortgages will be lower.\u00a0 Lower volumes equals lower profitability…supposedly.<\/span><\/p>\n

     <\/p>\n

    But isn’t it just as possible that the big commercial banks, like Bank of America and Well Fargo begin fulfilling a similar function like Fannie Mae and Freddie Mac have provided for almost half a century?\u00a0 I think so.\u00a0 Without the artificially advantageous, almost monopolistic qualities of the GSEs, isn’t it possible that the big commercial banks will step in and fill the vacuum?\u00a0 That vacuum is a highly profitable vacuum isn’t it?<\/span><\/p>\n

     <\/p>\n

    That’s because without the artificially low mortgage rates provided by Fannie and Freddie, spreads for banks between the cost that they borrow at (which will stay relatively fixed) and at which they then turn around and lend at, should widen.\u00a0 So perhaps profitability lost on volumes may be gained on fatter profit margins.<\/span><\/p>\n

     <\/p>\n

    I think, at the outset of the post-Fannie and Freddie frontier, that it is difficult to assess just what the effect will be on bank profitability.\u00a0 There will certainly be more competition.\u00a0 Usually in capitalistic markets, unfettered by the b.s. of a Federal government subsidy, there is usually a reduction in the costs to consumers and an increase in profits to the low cost providers of goods and services.<\/span><\/p>\n

     <\/p>\n

    There Will be Even More Financial Industry Consolidation<\/strong><\/span><\/p>\n

     <\/p>\n

    While the last thirty years has seen tremendous consolidation in the banking industry, sans Fannie Mae and Freddie Mac there will be even more.\u00a0 Why?\u00a0 In order to compete in the mortgage underwriting, mortgage-backed-securities, higher profitability market, banks will need to have scale.\u00a0 That scale is already in place for some of the larger national banks.<\/span><\/p>\n

     <\/p>\n

    However, there are a number of smaller, regional banks, that have competed on great service and knowing their local markets that will either be subsumed by the national players, or<\/span> they will buy up other regional banks in order to get big.\u00a0 Only with scale can you enter a market as a national underwriter of mortgage backed securities.<\/span><\/p>\n

     <\/p>\n

    The world will increasingly be dominated by fewer and fewer banks post Fannie Mae and Freddie Mac.<\/span><\/p>\n

     <\/p>\n

    Miscellaneous Changes<\/strong><\/span><\/p>\n

     <\/p>\n

    While it may seem as if financial institutions like Fannie Mae and Freddie Mac, once emasculated, would have only a financial industry affect, this is na\u00efve.\u00a0 For example, more mortgages equals more houses.\u00a0 More houses means a greater need for real estate.\u00a0 A greater need for real estate equals a greater need for land.\u00a0 A greater need for real estate has meant greater development where land was cheap.\u00a0 That cheap land has been in the suburbs.\u00a0 Greater population in the suburbs equals greater commutes.\u00a0 Greater commutes equals more pollution.\u00a0 Greater pollution equals more global warming.\u00a0 Yes, really.\u00a0 This is the cause and effect chain<\/strong> – sorry to say.<\/span><\/p>\n

     <\/p>\n

    Fannie Mae and Freddie Mac have created a whole host of problems for the world (in addition to their benefits).\u00a0 Unfortunately, if Fannie and Freddie go away, it’s my feeling that the slack will be taken up by other institutions, private institutions.<\/span><\/p>\n

     <\/p>\n

    There are a whole host of other possible ramifications – but I just wanted to highlight that nothing exists in isolation in the world.\u00a0 Indulge me.<\/span><\/p>\n

     <\/p>\n

    In conclusion, I think the ultimate benefit, net, of the dissolution of Fannie Mae and Freddie Mac, when all factors are considered, is that there is less risk in mortgage markets.\u00a0 This is a good thing.\u00a0 No, actually it is a very, very good thing.\u00a0 Que sera, sera.<\/span><\/p>\n

     <\/p>\n

    Jason<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

    In yesterday’s post I discussed the history and purposes of Fannie Mae and Freddie Mac, as well as the radical proposed changes to these two institutions as made by the administration of President Barack Obama.\u00a0 In today’s post I want to talk about the world post Fannie Mae and Freddie Mac.   Here are the […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-3496","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/3496","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=3496"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/3496\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=3496"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=3496"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=3496"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}