Paul Jackson is on vacation. His column ‘Lies, Damn Lies and Statistics’ will resume next Monday. In his absence, market veteran Linda Lowell takes on Hank Paulson’s recent assertions on the GSEs. Everyone wants a say on what happens to the GSEs, especially Hank Paulson. After all, he has standing in the matter. He’s the guy who designed (with Congress) the mechanism of their “bailout” and put them into conservatorship (though the Federal Housing Finance Agency, FHFA, was the fall guy). Who knows – he may be invited to the Treasury’s August 17 “Conference on the Future of Housing Finance”, first of several events (says Treasury) intended to collect input from the usual suspects on comprehensive housing reform, including the future of the GSEs. But just in case, he took advantage of forum offered by the Washington Post to outline his views with “Housing policy must be set on sustainable basis.” I so agree with the headline, but a couple of Hank’s deepest “thots” so reek (oops, I meant to say reflect) of his Goldmanic, superaffluent preconceptions, I put down my own comments regarding what I believe to be the true sustainable basis for housing finance (an authentic better-mousetrap mortgage design), to rebut. (I’ll be back next week with those comments.) Two Axes Hank’s recommendations for the GSEs are no surprise: strip the GSEs of the portfolios (eliminating the need for all that debt) and reconstitute their guarantee function in fully private-sector entities. It’s his other recommendation that gives me pause: once a housing recovery is clearly in sight “we must have the fortitude to create a more level playing field between housing and other productive investments.” According to Hank, a “root cause of the crisis was the combined weight of government policies promoting homeownership.” Those subsidies include the housing GSEs, the Federal Housing Administration (FHA), the Federal Home Loan Banks, the federal tax deduction for mortgage interests and various state programs. Hank says these subsidies “overstimulated” homeownership. Huh? These subsidies existed for decades without turning homeowners into dangerous forces that could destabilize the broader economy. A pro-homeownership policy simply allowed the government to ignore how homeownership was being financed by private lenders. It was the private-sector’s free-money “affordability” loan products and collapsing credit standards that turned ordinary citizens into super-size-me home grabbers. Private subprime lenders had FHA on the ropes (with a miniscule share of a burgeoning market), while so-called “Alternative-A” prime lenders devoured the lunches of private mortgage insurance companies with their piggy-back-ridden high LTV loans. It was the anything-goes no-doc alchemy of private lenders’ Alt-A that lured the GSEs onto the rocks. OK, they got a good push from Congress’ affordable housing goals, largely met by buying subprime securities (with HUD approval). But I’d argue that the winners even there were the private lenders, for whom selling and servicing GSE loans is big business. Don’t forget, either, that a number of the biggest Alt-A lenders were too-big to fail banks (and isn’t too-big-to-fail just another kind of crypto-GSE, public-private hybrid? answer me that, Hank!). Let Them Eat Hedge Funds Before I dig deeper into Hank’s merde-acity, let’s examine that sly “level the playing field between housing and other investments.” First off, until the credit bubble, housing was shelter, not an investment. Before free-money loan products, a home purchase was a savings vehicle. Households saved money to buy a house – a process that generally brought them up to be good stewards of their own resources – and then slowly added to those savings by paying down the mortgage. Modest appreciation generally kept up with inflation and sweetened the deal. I don’t think that amounts to any more an investment than, say, an old-fashioned whole life insurance policy. It took biggie-sized consumer leverage, as well as the disappointments of the dot-com bubble (for better healed households), to turn shelter into an investment. Second, Hank’s class-bound preconceptions are showing. What does he think is the investment opportunity set for most tax payers? A house, a hedge fund or an oil well? How many Americans does Hank think are accredited investors? Or is he thinking the tradeoff is between the 401-K (etc.) and the house – pretty much the two tax-sheltered investments available to the hoi poloi. And what middle-American household has access to the same amount of leverage in any other investment of the same magnitude? Finally, what might I ask, did the buyers who turned housing markets into housing bubbles invest? Their life savings? No. It was a product supported by no government housing subsidy whatsoever. A purely private product, the finest fruit of private enterprise ingenuity and innovation. Can you guess? A piggy-back mortgage! Well, I have overlooked one thing. The tax deduction for first and second homes. Perhaps that’s a bit generous, perhaps second homes should not qualify. I admit I haven’t got the legislative history in front of me, but I’ll bet cash dollars that second homes were included not because voters wrote and called their elected federal representatives in great numbers, but because home builders, realtors and other private enterprise interests at the trough lobbied for their inclusion. But the interest on loans on investment properties is not subject to that deduction – it’s a business expense, along with insurance, depreciation and so forth. And anyone who has looked at the characteristics of subprime, private and GSE loans made in the rush to the bust knows that the reported share of loans made to investors soared and was an important component of excess demand feeding excess home price appreciation. Moreover, the investor share of borrowings is understated. One of the notorious soft frauds (as opposed to outright larcenies) of the housing bubble was to claim the property was a primary residence not an investment – a soft fraud often accompanied by others, like lying about stated income. Put FHA and the GSEs Back in Their Place Give him credit, Hank doesn’t attack the tax subsidy for homeownership. He’s focused on reducing the extent of government-subsidized credit guarantees “by rationalizing and reducing the missions of the FHA and the successor(s) to Fannie and Freddie”, for instance by limiting the subsidy to smaller mortgages, lower income borrowers, or both. And the price of that subsidy should be high enough to leave lots of room for “robust” private mortgage lending industry. Wasn’t that, effectively, the policy in the last decade, when subprime lenders made FHA marginal and Alt-A lenders devoured a significant chunk of GSE market share? In, I’ll say it again, the run-up to the bust? Nonetheless, and here’s the mendacity, Hank says “Fannie Mae and Freddie Mac should not be allowed to revert to their old form, crowding out private competition and putting taxpayers on the hook for failure while shareholders benefit from success.” Fact: private competition crowded out Fannie Mae and Freddie Mac. According to the numbers in Inside Mortgage Finance Publications’ “2010 Mortgage Market Statistical Annual”, the market share of conforming conventional loans (traditional GSE loan, but could be held by portfolio lenders as well) shrank from 57% in 2001 to 33% in 2006 (the “top” for private originators; private mortgage markets began imploding in 2007). The FHA/VA share of total mortgage loans dropped from 8% in 2001 to 3% in 2006. In terms of securitization, the GSEs’ share of MBS issuance dropped from 68% to 40% over the same period, Ginnie’s from 13% to just 4%. Taxpayer versus shareholder pain? Hank’s forgetting that individual taxpayers and shareholders tend to be one and the same, thanks to the magic of retirement plans, 401-Ks, IRAs and retail equity investment products. Fannie and Freddie were S&P 500 companies before Hank took them down. That is, their market capitalization was great enough that they were very widely held by large mutual funds and the investment organizations managing pension and life insurance assets. The almost total loss in share value and suspension of dividends came right out of middle class pockets. The shareholders who gained from the GSE business model were those who cashed out with gains. And of course, going into the endgame, the short sellers. I still have a modest position in Freddie Mac shares. In my first free moment, I intend to compare the dividends I received over the years to the loss when those shares become worthless. I’d be amazed if, shareholder that I am, I offset any of the added burden I face as a taxpayer. Last word to Hank: the housing bubble was blown by financiers, not government promotion of home ownership.
NOTE: Linda Lowell writes a regular column, called Kitchen Sink, for HousingWire magazine.
Editor’s note: Linda Lowell is a 20-year-plus veteran of MBS and ABS research at a handful of Wall Street firms. She is currently principal of OffStreet Research LLC.
