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GSEs Into Conservatorship: Can Housing Stabilize Now?

by: TheLFB September 07, 2008 | about stocks: FNM / FRE    

TheLFB

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Now that Treasury has taken the GSE’s into conservatorship it is likely that the housing market can begin the process of stabilization and recovery. The Treasury’s take-over of the GSE’s essentially means that the government will be providing liquidity into the mortgage market by way of re-starting the all-but-defunct secondary market for mortgages with planned purchases mortgage-backed debt. This will have an important implication for the dollar, which is discussed later.

One of the main features which enabled the housing market’s expansion was the change from the originate and hold model of mortgage lending to the originate and distribute (sell) model. The market for mortgage securitization basically dried up after August 2007 but now, the government will be there to make the purchases that no other entity can (or is willing) to make. Essentially, the government is taking the other side of the mortgage securitization trade as the buyer of mortgages that financial firms will again originate and distribute (sell). Now that liquidity is expanding, which means the supply of money within the mortgage system will increase, it is likely to see mortgage rates decline. Once mortgage rates decline, that obviously will make housing more affordable even if housing prices themselves hold steady because the monthly cost of carrying a mortgage will decrease.

In a previous article, we estimated where mortgage rates would need to decline to in order to make a house priced on the median (according to the NAR) affordable to a household earning the median (as defined by the Census Bureau) using an industry standard maximum of 28% of monthly income as an affordable cost to carry a mortgage. Under these circumstances, we found that if the current NAR median home price were to remain constant, current mortgage rates for a 30-year, fixed rate mortgage would need to fall to 5.63% in order to meet the requirement of affordability.

There already are some very interesting things happening in the housing market when you look at the numbers from the National Association of Realtors.

First, the median sale price of an existing home has been increasing since January even as inventories (due in part to the increase in foreclosures), expanded. This is partially explained by a new study from the National Bureau of Economic Research [NBER], which concluded that “the impact of foreclosures on prices, while negative and significant, is quite small in magnitude.”

Second, the large declines in the seasonally adjusted annual rate [SAAR] of existing home sales and median sale prices occurred between August and September 2007. Economists tend to look at the housing statistics in a year over year basis, and here is where things are about to get very interesting.

If the SAAR of existing home sales holds at the present level (5.0M) by the time we get to the report for September (which will be issued in October), the year over year decline (which was -13.2% in the year to July) will be just -2.15%. Even if September sales hit the average SAAR for 2008 (4.93M), the yearly decline will be -3.52%, which is still a marked improvement. As far as the median price is concerned, if the present level ($212,400) holds into September, the year over change will be for an increase of 0.9% versus the 7.1% decrease which occurred in the year to July. But even if September’s median price falls on the 2008 average ($204,570) the yearly decline will be reduced to 2.81%.

The bottom line here is that once we get the report for September, the housing market (except for inventories) is likely to be statistically much improved over what we have been seeing for a long time.

Implications For The Dollar

The dollar is likely to continue appreciating against the high-yielding currencies (EUR,GBP.AUD and NZD). Against the yen, appreciation will happen if the stock market can find its footing. The main reason to expect further dollar appreciation is twofold:

1. The Federal Reserve has real rates of interest which are negative, while the BOE,ECB,RBA and RBNZ do not. The pound has an especially large potential to fall, because the BoE is scheduled to cancel its special lending facility on October 20, a move which will decrease liquidity as the U.K. economy goes into contraction.

2. The move by the Treasury to take over the GSE’s and provide liquidity (a market) for mortgage securitization will allow housing to begin the stabilization and recovery process, especially if mortgage rates can decline.

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This article has 19 comments:

  •  
    Sep 07 03:54 PM
    Banks have hundreds of Billions to recoupe and more write downs coming. Even if you zeroed out the GSE's, I can't see how putting $2 Billion into the market will add liquidity to an already financially strapped market that's losing hundreds of Billions a quarter. If the GSE's don't have funds on the books to cover their oustanding debt, how will adding money do anything but help balance the books? There is no additional liquidity added here. With preferred and common taking a big confidence hit and haircut, how are they going to find investors to steal money from? How are they going to make up for the $36 Billion that will dissapear on Monday when preferred's cash out? Hank just told the banks to cash out and he would help them account for their losses.

    With a diluted portfolio, government sovereign ratings go to junk very soon, banks will face decreasing liquidity, and we will be looking at 15% rates very soon. Great plan.
    Reply
  •  
    Sep 07 04:46 PM
    So investorslive, how do you explain the spread between the fed rate and mortgage rates? The fed lowered rates and the mortgage rates went up. What makes you think having the government explicitly back $5 Trillion in bad debt will help the credit market or improve the spreads. Hank just affirmed to the world that the GSE's paper is toxic and virtually worthless. Just because it's government backed doesn't make it good and taking on this much debt doesn't make the treasury's sheets any better either. Your post might excite day traders, but it is just wishfull thinking.
    Reply
  •  
    Sep 07 04:59 PM
    "Just because it's government backed doesn't make it good and taking on this much debt doesn't make the treasury's sheets any better either."

    What a stupid comment. Government backed is risk-free. You'll see mortgage rates drop now. Watch it happen. Paulson may be a lot of things but he's no dummy and this is all planned.
    Reply
  •  
    Sep 07 06:33 PM
    The Treas is only buying GSE MBS; it's not buying private-label MBS, so the notion that this will bring back the secondary market is ill-founded. And it's highly questionable about the volume of mortgage origination that will be absorbable by the GSEs now; there are a lot of issues to work through before the GSEs are fully open for business again. And on top of that all, there is still the open question of how many borrowers have the collateral and credit quality today to actually refi or buy....

    This isn't over, not by a long shot!
    Reply
  •  
    Sep 07 06:41 PM
    Are you referring to the same smart Hank Paulson that told the world he had no intention of using the backstop because the GSE's have plenty of capital last week? Also the same guy that told the Chinese to pull out before he intervened and told the world today the GSE MBS's are in big trouble? Seems like a genious to me....

    Who in the world is going to hold their stock, preferred or common now? That's an immediate $36 Billion dollar loss in comany value my friend. How much is it really going to take for the GSE's to break even after all of the double talk out of Washington?

    What Hank really said today is that our mortgage backed securities we said are worth $5 Trillion are not really worth it, but trust me, they are now that the fed, who is also $12 Trillion in the hole, stepped in and is now backing this debt with monopoly money... The government is one heck of a co-signer. If the government and the dollar is so great, why are foreign banks dumping dollars and converting to Euro's?

    Where is this liquidity going to come from to lower rates? Ben lowered rates and mortgage rates went up. why? Banks don't have it to loan. Supply and demand... Hank just said the GSE's would shrink by 10% a year. That doesn't sound like the GSE's are going to add liquidity either. Game over. Thanks for the stupid feedback.
    Reply
  •  
    Sep 07 07:17 PM
    I wrote the above article and I'm glad to see the comments here. According to the statement made by Mr. Paulson, "to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS." This is where the liquidity will be coming into the mortgage system and this is the reason mortgage rates are likely to fall. Banks will be able to originate and distribute because the government is taking the other side of the securitization trade, as I mentioned in the article.

    Additionally, the lending facility will be extended to the Federal Home Loan banks.

    Mr. Paulson went on to say that "given the combination of actions we are taking, including the Preferred Share Purchase Agreements, we expect the GSEs to be in a stronger position to fund their regular business activities in the capital markets," which means that credit spreads are likely to narrow.

    This is more liquidity into the system and lower borrowing costs. It's expansionary.

    Reply
  •  
    Sep 07 08:30 PM
    prescient11 writes:
    Government backed is risk-free.

    Free of risk as long as the government has the ability to pay it back. Do you see taxes going up to pay them back? Or do you see the government printing the $$ to pay back the debt and if I were holding treasuries I would sell them like if they were toxic because THEY WILL NOT BE PAID BACK
    Reply
  •  
    Sep 07 09:03 PM
    You're an idiot if you believe a word coming out of Paulson's mouth. They couldn't care less about "availability of mortgage financing for millions of Americans". It's all about stealing money from taxpayers to fill the pockets of his pigmen buddies. WAKE UP ALREADY!
    Reply
  •  
    Sep 07 09:23 PM
    "What a stupid comment. Government backed is risk-free."

    I think you got these two sentences in the wrong order. Did-it-again has it right.
    Reply
  •  
    Sep 07 09:57 PM
    Everyone is forgetting one thing - you need a job to buy a fricken house. The economy is getting worse - lol and this will not create a demand for housing even under your assumption rates drop.Which by the way is open for debate. Credit contraction is firmly in place. We have reached " PEAK CREDIT " the herd is tapped
    Reply
  •  
    Sep 07 10:59 PM
    Your comments would be right in a perfect world Mr. Carniol. The credit spreads should narrow, but they won't. The 30 year mortgage rate is linked to the 10 year T bill +2.5%, so if the T bill goes up, so does the mortgage rates. T bills usually follow the vix (too much risk in the market drives everyone to stable T bills), but funny thing is they are on their own. There is no confidence in the treasury around the world so no one is buying T bills. Today's actions did exactly what I said it would, T bills rates jumped .2% in asia on the news. That means mortgage rates are back up .2% from Friday's close. Asians are saying the treasury took on too much risk this time. I agree with them. So much for the drop in rates.

    What do we do next?
    Reply
  •  
    Sep 08 12:13 AM
    I think the jury is still out here-S&P futures are up nearly 3% so far and there's a long way to go. In any event, we really won't know how this turns out for a bit so let's return in a few weeks and see how things look.
    Reply
  •  
    Sep 08 01:51 AM
    home prices are falling at 10% rate yoy and the treasury is going to buy some of those MBS. those mortgages better be with 20% down payment. ahhh, how many people can put down 20% for a new home? well, maybe the housing market will not stabilize as soon as you see it.

    and how about the secondary market? when those monsters start in 2010 MBS fire sales in the tune of 150bn per year? you think those will not be significantly discounted to change hands?
    Reply
  •  
    Sep 08 03:13 AM
    WALL STREET WILL GET BACK ON ITS FEET FOR A WHILE, BUT THE COMMON MAN SHALL STUMBLE UNDER THE WEIGHT OF HIGHER TAXES AND INFLATION, AND WITH THAT WALL STREET AND THE ECONOMY WILL CRUMBLE.
    Reply
  •  
    Sep 08 07:42 AM
    If the US Government actually holds all of the GSE's, etc. for 5 or more years, they may actually end up making a huge profit. For now it is good that banks will be more likely to make loans, when they know they can sell some of them to FNM and FRE. FNM and FRE are now more clearly government backed. Thsi ought to help stabilize the housing market.
    Reply
  •  
    Sep 08 11:13 AM
    "What a stupid comment. Government backed is risk-free."

    Tell that to the folks in Zimbabwe.

    According to the pie chart on the tax forms, in 2006 we paid 6% of our national outlay merely to pay interest on the debt. Since then, the debt has expanded a LOT, and this will boost it still more.

    How long until Uncle Sam has trouble making the payments on the interest?

    Yes, he can always kick the monetary printing presses into high gear, but to reiterate my initial point, just ask the folks in Zimbabwe how well that has worked out.

    When we have a national interest expenditure in the 15% and up range, it will be VERY DIFFICULT to get the debt under control (as if it wasn't difficult before!).
    Reply
  •  
    Sep 08 03:02 PM
    Everyone assumes bankers know what they are doing, if they did how did we get here. as mentioned above, a while back the "sub prime mess" was contained, later the GSEs are well capitalized and can do their job. Next came "more banks will fail" but if FDIC needs money we can carry them too. LEH will sell ???? to raise capital, all is well but did they sell???
    We have a new president and administration coming in a few months, will all the financial balance sheets be clean by then or does anyone know what is on the balance sheets. NAR says getting better, but they have been saying that for 2 years. Builder earnings down, but I think I see something at the end of the tunnel. Autos and airlines next for bailout.
    It seems we only gave a breather to the MBS/CDO/etc foreign debt holders provided the government will do a better job of running Freddy/Fannie or maybe call the FSBOs.
    Reply
  •  
    Sep 09 01:51 AM
    Please check the wording on most/all Mortgage Equity Contracts. See the abbreviation LIBOR. LIBOR spiked up on this news.

    Mortgage Rates will not drop unless LIBOR drops.
    Meanwhile, rates on lines of HOME Equity continue to increase. To offset this, the Fed should be lowering interest rates. Inflate now and do it fast, because the next round of foreclosures will be accelerated by the departure of homeowners whose lines of Equity Borrowings exceed the value of their homes and their rates rise.

    Wealth Destruction = Deflation.
    Reply
  •  
    Sep 20 08:29 PM
    We are all screwed in laymen's terms. If we want to fix this problem we all have to have 1 goal in mind and that is to work off our national debt. We all partied and drank some more than others but its true. So everyone is guilty one way or another!!!!!!!!!!!!!
    Reply
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