07.31.2010 0

The Mother of All Bailouts

  • On: 08/05/2010 21:45:34
  • In: Economy
  • By Robert Romano

    Some 15 million of the approximate 55.95 million mortgages nationwide are said to be “underwater” or in negative equity, i.e. the market value of the home is less than the total value of the mortgage. That’s about 26.8 percent of all mortgages. And according to Reuters’ James Pethokoukis, it represents about $800 billion negative equity.

    Now, Washington is apparently abuzz that the Obama Administration is planning on reducing the principal owed for mortgages guaranteed by Fannie Mae and Freddie Mac. In theory, this would give the so-called “underwater” homeowners an opportunity to sell their homes without losing any money in the process.

    That may sound nice (for those homeowners). But the fact is, somebody else will have to pay the difference. So, what would this mean, and how much would it cost?

    Fannie and Freddie guarantee about $5.5 trillion worth of mortgages, about 53 percent of all mortgages. That’s how much they paid for the mortgages. But if they are forced to eat the negative equity, the Government Sponsored Enterprises (GSEs) could lose $424 billion. That’s a lot of money.

    Now, unless the intention is to render Fannie and Freddie completely insolvent — well, more insolvent than they already are — and to render the GSEs incapable of purchasing new mortgages on the secondary market, then somebody will have to pay for that $424 billion bailout.

    That somebody could be the Federal Reserve. Although, it already owns $1.117 trillion (which was simply printed) of GSE mortgage-backed securities, which it is slowly selling off. By all indications, the Board of Governors is done with its intervention into the GSEs. That it would now suddenly guarantee all of the negative equity of Fannie and Freddie mortgages would be quite a revelation.

    So, if not the Fed, that somebody would have to be taxpayers, represented by the U.S. Treasury. Of course, taxpayers have already been forced to put $145 billion into the mortgage giants to keep them solvent. But that wouldn’t stop the Obama Administration, would it?

    To raise the $424 billion, the Treasury would simply have to issue new obligations, which would be piled atop the national debt. First, there might be an attempt to sell treasuries on the bond market. When that fails, the Federal Reserve would have to purchase the rest with monopoly money. More ink and paper.

    Edward Pinto, former chief credit officer of Fannie Mae, wasn’t kidding when he told Bloomberg News that the unlimited Treasury guarantees to the GSEs were “the mother of all bailouts.”

    Of course, often ignored is the fact that no bailout is actually unnecessary. Not every “underwater” homeowner is currently attempting to sell his or her home, or even is in danger of default. The only time the value of the home matters — besides when property taxes are levied — is when a home sale is occurring.

    Nobody is forcing the “underwater” homeowners to sell their houses at the bottom of the market. But even if they did sell, the fact that homeowners might take a loss on their investments is not the end of the world.

    After all, not all investments appreciate in value. When losses occur, the holder of the investment takes the loss. It’s actually the essential element of having markets at all; there are winners and losers. If that dynamic is taken out of the market, then there is no market. It’s all government subsidies.

    In this case, if the principal owed by “underwater” homeowners is reduced, taxpayers will be the losers. There’s no other way around it. The government will cover the losses by borrowing and printing more money, leaving the tab with taxpayers.

    A more responsible path would be for the government to get out of the way, and allow the “underwater” homeowners to bear these negative equity losses — when they sell their homes, since again, nobody is forcing anybody to sell their homes now.

    The government could help return certainty to the market, also, by cancelling all foreclosure “prevention” programs. Federal mortgage modification programs, such as a recent $75 billion Treasury program, have already failed anyway. Pinto recently testified to Congress that as many as 40 percent of attempted government modifications would likely re-default anyway.

    So, bailing out millions of “underwater” homeowners will not prevent foreclosures either. It will not even help the housing market to recover. Instead, it will just add another $424 billion to the nation’s $13.3 trillion debt at a time when taxpayers are really the ones who are underwater.

    Robert Romano is the Senior Editor of Americans for Limited Government (ALG) News Bureau.

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