Washington's Lousy Real Estate Portfolio

Federal housing bureaucracies are failing. They need to fail faster.


These are tough times for government real estate policy. In December the Securities and Exchange Commission indicted six former executives from the failed government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, including former Fannie CEO Daniel H. Mudd and former Freddie CEO Richard F. Syron, on charges of fraud, alleging that the GSEs misled investors and the government in statements claiming they had minimal holdings of low-quality and subprime mortgage loans. 

Throughout the housing bubble of the late 1990s and early 2000s, Freddie and Fannie, which guarantee mortgage loans and thus provide a substantial interest rate subsidy, had been concealing the large portions of their portfolios consisting of risky investments such as alt-A, subprime, and negative amortization loans. Fannie Mae finally copped to the deception in the third quarter of 2008, long after the housing crash and its attendant recession were in full swing.

Fannie and Freddie (founded in 1938 and 1970, respectively) were quasi-private, government-guaranteed players until 2008, when they were taken over by the Treasury Department. In 2009 Freddie CFO David B. Kellermann hanged himself in the basement of his Vienna, Virginia, home, leaving behind a wife and 6-year-old daughter. In 2010 Fannie and Freddie were delisted from the New York Stock Exchange. In 2011 Sens. John McCain (R-Ariz.) and Orrin Hatch (R-Utah) introduced legislation to dismantle or privatize Fannie and Freddie over five years. The Treasury has slightly reduced the GSEs' purview, but they still guarantee more than 90 percent of U.S. mortgages.

There is more bad news from the Federal Housing Administration (FHA), which is taking riskier positions in real estate lending just as the rest of the country is looking to reduce indebtedness. Wharton School real estate finance professor Joseph Gyourko warned in a recent study that the FHA, the world's largest insurer of mortgages, is shaping up as the next likely target for a bailout. (See "Housing Bailout Redux," page 14.) Gyourko raises three points: The FHA has increased its risk exposure without anything close to a commensurate scaling up of its capital base; it is underestimating future default risk and losses on its single-family mortgage guarantee portfolio by at least $50 billion; and it needs to recapitalize to compensate for these risks.

While the FHA has contested some of Gyourko's findings, the condition of its books continues to deteriorate. The agency raised its asset base by $400 million in 2011 (and points to this as proof of increased financial health), but it also issued $213 billion in new loan guarantees during the same period. Ed Pinto, a senior fellow at the American Enterprise Institute, calculates that as of last October, 17 percent of FHA-insured loans were in some stage of delinquency. Its "serious" delinquency rate (more than 60 days overdue on loan payments) is more than 9 percent and has been increasing steadily during the last year. More than 836,000 FHA loans, with a total outstanding balance of $117 billion, were 60 or more days delinquent. The FHA is on the hook for 100 percent of its busted loans, and to make things more ominous, it seems to be using older, rosier statistics when calculating its risk. 

In November the Obama administration even managed to walk back one of the few things the FHA has done right in recent years: allowing its expanded conforming-loan limit for "high-cost areas" to lapse. Early in the real estate correction FHA upped its conforming loan limit (the mortgage amount that taxpayers guarantee) to $729,750. That emergency increase expired on October 1, when the limit dropped back to $625,500. But this reprieve lasted less than two months: After five straight years of declining house prices, the upper limit is back up to $729,750. Assuming a 20 percent down payment, that puts the government in the odd position of providing a housing subsidy to people living in $1 million homes. 

The FHA might hope to escape the consequences of this high-risk behavior if the real estate market were poised for a stunning recovery. That is not the case. Lender Processing Services (LPS), the controversial company that handles about half of all foreclosures in the U.S., reports that the percentage of mortgages in foreclosure is at its highest level ever. "Foreclosure inventories are on the rise," LPS said in a November report, "reaching an all-time high at the end of October of 4.29 percent of all active mortgages." 

In December the National Association of Realtors (NAR) ended another charade by conceding it had overstated real estate sales for the period from 2007 through 2010. In fact, more than 3 million existing home sales that users of NAR data (including much of the popular press) had been counting never actually happened. For 2010 alone, sales were overstated by nearly 15 percent; the realtors had claimed $100 billion in phantom transactions. 

The dire condition of federal real estate bureaucracies may worry those who believe in good government, but for the rest of us it's hard to get upset about the illness of agencies that are poisonous even when healthy. The GSEs and the assorted agencies of the Department of Housing and Urban Development—of which FHA is just one mischief maker—have created trillions of dollars' worth of false credit, false wealth, and false sales. Middle- and lower-income Americans have either been priced out of the housing market or nudged into the tyranny of the 30-year mortgage (a financial instrument that would almost certainly not exist if not for government policy). Pro-inflationary real estate policy has enjoyed the overwhelming support of both the ruling parties for decades.

Now that is changing. The threat to federal housing policy is coming not just from the failure of its institutions but from the failure of its logic. Americans who have already taken on homes have in the last year reduced their mortgage debt and are building up equity—a reversal of a three-decade trend in which debt took up an ever-growing share of real estate assets. New homebuyers see prices falling and are willing to wait until houses are affordable for a person of average thrift and ambition. Banks are, after a scandal-plagued delay, beginning to own their bum loans and liquidate foreclosed property; this in turn raises the prospect that the real estate market might hit bottom this decade. These are causes for hope: Despite the planners' most strenuous efforts, the market still might work. 

Tim Cavanaugh is managing editor of reason online.

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  1. In 2009 Freddie CFO David B. Kellermann hanged himself in the basement of his Vienna, Virginia, home…

    I wish my basement had higher ceilings.

    1. Wanna give some government officials a place to hang themselves?

      1. The founders would have ‘helped them’ with this decision.

  2. Failure is part of capitalism. We need to allow it to happen again, even in double-special, government-loved industries.

    1. Failure is part of capitalism.

      But this wasn’t failure… it was market failure. Big difference. So yeah, we have to prop it up, at all costs.

  3. I imagine real estate in the DC area is still doing great, though. 9 of the top 15 counties in the US by median household income are in the DC MSA and one (Howard County, MD) is in the Baltimore MSA but is about equidistant between the two cities. It’s good to be the kings.

  4. Warren@theBuffett says Banks are the true victims. I feel their pain.…..nners.html

    1. Buffett is correct (once again). The mortgage bubble was a free market failure and the left wants to blame only the banks for it.

      Wingnuts hate him for his rationality and the OWS idiots hate him for his money. I like him for his capitalism and reason.

      1. The mortgage bubble was a free market failure

        No market distorted by Fannie and Freddie can be called a “free” market.

        1. But some of the banks tried to “out Fannie” Fannie Mae by copying their business model.

          Lehman, Bear, and Citi, for three examples. They did it on their own volition – like idiots and not by regulation like the dumbasses on the right claim.

          1. “Lehman, Bear, and Citi, for three examples. They did it on their own volition – like idiots and not by regulation like the dumbasses on the right claim.”

            And of course they were acting in a market with no perverse incentives like other dumbasses claim.
            Right, dumbass?

          2. Citation as to how those entities’ contributions were the cause of the housing bubble versus Fannie and Freddie please?

            1. The private market was free to engage in subprime.

              The GSEs were not. A GSE could only buy a “conforming” loan.

              Its that basic.

              1. “A GSE could only buy a “conforming” loan.”

                Right, especially if you’re real clever with defintions:
                “Under reasonable definitions of subprime, almost 30 percent of Fannie and Freddie direct purchases could be considered subprime.”

                1. Your Cato link fails to define subprime while making wild claims with no substance.

                  The GSE model defined subprime as less than a 580 FICO (as I recall – I could be wrong).

                  But Cato is winging it. I know that.

                  1. Sure, shreik. Maybe a course in remedial reading might help you:
                    “During the height of the housing bubble, almost 40 percent of newly issued private-label subprime securities were purchased by Fannie Mae and Freddie Mac.

                  2. Was the SEC winging it?

                    Fannie Mae reported that its 2006 year-end Single Family exposure to subprime loans was just 0.2 percent, or approximately $4.8 billion, of its Single Family loan portfolio. Investors were not told that in calculating the Company’s reported exposure to subprime loans, Fannie Mae did not include loan products specifically targeted by Fannie Mae towards borrowers with weaker credit histories, including more than $43 billion of Expanded Approval, or “EA” loans.


                    1. Only $4.8 billion?

                      That is a trinket relative to the market.

                      And in 2006?

                    2. shrike|2.27.12 @ 3:39PM|#
                      “Only $4.8 billion?”

                      Are you blind?
                      “Investors were not told that in calculating the Company’s reported exposure to subprime loans, Fannie Mae did not include loan products specifically targeted by Fannie Mae towards borrowers with weaker credit histories, including more than *$43 BILLION* of Expanded Approval, or “EA” loans.”
                      See that $48Bn there, shriek?

                    3. $43 billion? Puny. Mark the property at 60% and the losses are small.

                      Still has NOTHING to do with private losses.

                    4. “Still has NOTHING to do with private losses.”

                      Keep repeating that shriek. There’s probably someone as ignorant as you who’ll buy it.

                  3. So by your own admission, a guy with a 581 FICO (what’s that, no bankruptcies in the last 3 weeks?) and 3% to put down was “Prime” to the GSEs.

                    Baghdad Bob would have been ashamed to make the argument you’re making.

          3. ZIRP policy and implicit bailout guarantees are but two examples of how the market was not, and is not, free. Fannie and Freddie are boils on the ass of cronyism. Stop calling it a “free market failure” because that is precisely the opposite of what it was.

            1. Shrike is a capitalist the way the left understands the term – a wanna-be rent seeker. That’s why he loves mega-rich bootleggers like WB.

            2. …a market with a completely regulated money supply (i.e., the Federal Reserve) was a “free market.”

              Complete horseshit.

      2. shrike|2.27.12 @ 12:25PM|#
        “The mortgage bubble was a free market failure>

        It was so “free” it was run by the government! Can’t get “freer” than that!

      3. The mortgage bubble was a free market failure and the left wants to blame only the banks for it.

        You keep using that terminology. I do not think it means what you think it means.

  5. Despite all the lamentations from the wingnuts about the GSEs the Boehner House has proposed nothing concerning them.

    Why? There is no solution. Nothing. You couldn’t give the fuckers away with their debt levels.

    1. Here’s a solution: since the government is already on the hook for the debt, the government should seize control of both entities for the purpose of bankrupting and liquidating any assets they do have. Outstanding loans should be auctioned off over a period of a few years, and MOST importantly, NO MORE LENDING SHOULD GO THROUGH EITHER AGENCY.

      Whew that was a real difficult solution to think of.

      1. Fannie and Freddie were seized in 2008. Their stock/equity is worthless.

        How does one go about an auction on negative equity?

        Then there is the problem of implicit federal backing to creditors. There is no real solution.

        1. Negative net equity. There is plenty of equity.

  6. The mortgage bubble was a free market failure

    Ja, sure, you betcha.

  7. How does one go about an auction on negative equity?

    Are you really (don’t answer!) that dumb? You auction the “assets”.

    Then there is the problem of implicit federal backing to creditors.

    How about a, you know, explicit refusal to backstop the assets? You know, “Where is, as is; now warranty, expressed or implied.”

    Get that shit off the books at real current market value, and stay the fuck out of the housing market henceforth.

    1. The losses are what they are, and are sitting on the government’s books now.

      Sell the assets, recognize the losses, dissolve the GSEs, prosecute where appropriate, and move on.

      1. Not true since there are unrealized losses.

        You stick to law and leave finance/money/capitalism to me.

        1. Those “unrealized” losses are still on the government’s nickel. They are what they are.

          Realize them and be done with it.

          1. The government’s nickel is now our nickel. I hope FoE has a real big basement.

        2. Trust me with managing financial things. What a great idea!

          I’m a fucking idiot.

  8. NO warranty

  9. unrealized losses.

    Sunk costs.

    So what?

    Forward is that way.

  10. prosecute where appropriate

    “Paging Mister Raines! Paging Franklin Raines!”

  11. Failure is part of the risk-reward system. Many companies go under in a free market due to bad decisions or bad luck. It happens.

    The real trouble is when the public becomes the underwriter for the loans that prop up the bad decisions or bad luck. This situation is what leads to really large losses in the market as those who are making the decisions are not risking their own money.

    The housing market should become a case study for all that is wrong with government intervention in the market place. It sometimes look good for a while, but eventually you get a far bigger bubble than is ever possible than when people are only risking their own capital.

  12. I smell a bailout!!!!!!!!!!!!!!!!!!!!!!

    1. you’re over three years late to the party

      1. don’t interfere, he’s on a role

  13. Why is the govt in this business? No other country that I know supports the housing market in this way. If the loan is creditworthy, the private sector will buy w/o govt gte. Lets keep the pressure on and support McCain and Hatch’s initiative.

  14. RC Bass|2.27.12 @ 4:53PM|#
    “Why is the govt in this business?”

    Ignoramuses like shriek vote; that’s why.

  15. Lehman, Bear, and Citi, for three examples. They did it on their own volition – like idiots and not by regulation like the dumbasses on the right claim.

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