The Fannie & Freddie Bailout: Less Than Meets the Eye

"Fannie and Freddie Offer Relief" is the headline

– but is this relief real, or is it little more than taking an aspirin

while losing a limb? For a coherent answer to that question, don’t go to the

press. The problem there is that journalists (a) think that anything new is

necessarily important, and (b) don’t generally understand the arcana of the

market in mortgage-backed securities.

Instead, go to the blogs. Specifically, go to the incomparable Tanta, over

at Calculated Risk, who has

the details, including, helpfully, a link to the original source: Freddie’s

press

release.

The main thing to note, as Tanta says, is that the market in subprime loans

was $450 billion last year alone. The injection of $20 billion over a period

of two to five years is not going to make a huge amount of difference. As we

saw

on Monday, there is a pretty liquid market in subprime loans already –

and, crucially, in the subprime loans which have already been originated, rather

than hypothetical subprime loans which may or may not help out borrowers in

future.

The idea behind the F&F announcement is that there are borrowers burdened

with toxic subprime mortgages who will, soon, face nasty resets, driving their

repayment costs through the roof. Fannie and Freddie are saying that they will

buy securities based not on those toxic mortgages, but rather on new, less toxic

mortgages which will be used to refinance the original ones.

Nowhere, however, is any mention made of what will happen with the enormous

prepayment penalites which make such refinancings extremely expensive for borrowers.

And the whole reason why many subprime borrowers are getting into trouble is

that they took out loans with low initial teaser rates because those low initial

rates are all that they could afford. If they’re now being offered loans with

more realistic interest rates, it’s far from clear that will actually help.

To put it another way: the problem is not predatory lending, where banks offer

loans at sky-high interest rates to mugs who don’t know any better. The problem

is that people are buying houses they can’t afford, thanks to mortgages with

ridiculously low interest rates. (At least for the first year or so.)

And a new mortgage can’t solve that problem.

There is some good news in yesterday’s announcements, but it doesn’t have much

to do with the headline $20 billion figure. What Fannie and Freddie announced

yesterday is important rather because it finally creates an official criterion

for what constitutes a good subprime mortgage. Banks love to write loans which

conform to F&F’s standards, and now they can do that in the subprime market.

That will go a long way to reducing the amount of dodgy mortgages being written

– although of course underwriting standards have already tightened up

an enormous amount since last year.

In the meantime, though, individuals facing foreclosure today, or people who

live in a house they can’t afford, should take little comfort from the headlines.

None of this is going to help them in the slightest.

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