Fannie and Freddie Bailout: Initial Thoughts on Firing the Bazooka

Treasury Secretary Paulson has used the bazooka. Instead of dealing with uncertainty, hated by the market, there is now a plan in place. What does it mean?

Initial ThoughtsThis plan will require study by all — including us — but there are a few conclusions that stand out. Each can and should be further explored, especially with respect to quantification.

  1. This is good news for the housing market. Mortgage rates should move lower, enabling interested and qualified buyers to have better access to loans. This is a crucial step in finding a bottom in the housing market.
  2. It is time to assess the latent demand for housing, and we will start to see data. Reports on home sales show the existing “supply” divided by the rate of sales to show inventory. If there are more qualified buyers, the supply figures could change rapidly with increased transactions. There may also be an increase in supply, of course, from those who have waited to put homes on the market.
  3. Paulson’s hand was forced by the market, especially the widely-publicized reluctance of major players like Bill Gross and sovereign wealth funds to invest further in the GSE’s. This is not an action that the Bush Administration wanted to take, but rather a case of the Street influencing public policy.
  4. Paulson still wants to do as little as possible. The actual increment of government investment in Fannie and Freddie is limited, while the support for existing loans is maximized. The plan is designed to maximize effect while minimizing actual involvement.
  5. The stated reasons for the change are lame. There is nothing new in the accounting facts cited in the proposal. Anyone paying attention knew that the GSE’s had traded off the government push for more aggressive lending with the more conservative advice of risk managers in the companies. The inclusion of potential losses in the balance sheet was also widely known and understood. This is a simple matter of the government changing the rules when confronted with the reality of market perception.
  6. The “moral hazard” lessons are mixed. Does it teach a lesson to risk-seeking investors? Perhaps. Does it teach a lesson to those believing that the government is partner? Yes! This deals a severe blow to the entire concept of partnerships between government and private enterprise. Whether or not this is a good idea is a topic for further analysis.

Conclusions

The Paulson plan will initially expand GSE balance sheets, providing more access to loans. Starting in 2010 it will reduce the role of government.

The big question: What mortgage lending structures will evolve to replace the role of Fannie and Freddie?

And the corollary: Is the business of securitizing mortagages a good idea that was poorly implemented? And will it rise again?

2 Responses to "Fannie and Freddie Bailout: Initial Thoughts on Firing the Bazooka"

  1. Duric Aljosa   September 8, 2008 at 11:09 am

    How bad is inflation in Zimbabwe? Coming soon: what shall we call the next maximum? Americanillion, or a Worldillion?

  2. PacificGatePost   September 9, 2008 at 2:03 pm

    OMINOUS SIGN BEHIND PAULSON’S ACTIONShttp://pacificgatepost.blogspot.com/2008/09/secretary-paulson-reasures-foreign.htmlAnd as usual the taxpayer is on the hook in the biggest bailout ever, and forever after that.