More chunks fall off the façade
A July update on the housing led business cycle
| We trim and blend three 2008 articles on the continuing unraveling of the business cycle, a phenomenon led by housing prices – actually land prices – returning to Earth, from the BBC July 1, from Reuters July 1, and from NPR July 10. |
by Jeffery J. Smith, July 2008
BBC: The UK cycle is about a year behind the US. In Great Britain, house prices fell by 0.9% on average last month. The decline was less severe than the record 2.5% fall seen in May, but prices were now 6.3% lower than a year ago. It was the eighth consecutive monthly fall in prices.Reuters: Late payments on home equity lines of credit rose to a 21-year high in the first quarter. The percentage of home equity lines more than 30 days past due rose to 1.1% from 0.96% the prior quarter. That rate is the highest since the ABA started collecting the data in 1987. Rising food and gas prices have also forced people to fall behind in paying credit cards. Bank card delinquencies also rose in the first quarter to 4.51%, slightly above the five-year average delinquency rate of 4.4% for the category.
NPR: Fannie Mae and Freddie Mac together hold or guarantee about $5 trillion worth of mortgages, making them key players in the nation's housing market. As credit markets have dried up, Fannie and Freddie have played a pivotal role in keeping mortgage markets afloat. The fear is that the failure of one or both would wreak havoc on the nation's financial system — and the broader economy as well.
Fannie Mae and Freddie Mac are the largest buyers of home loans in the nation. They buy home loans from lenders, then hold them in their portfolios or repackage them into bonds — known as mortgage-backed securities — that are traded on Wall Street.
The big thing they do is guarantee all the loans that they sell to investors. Now homeowners are defaulting and being foreclosed on at alarming rates, so Fannie and Freddie are being forced to make good on those guarantees to investors. Already they've posted combined losses of $11 billion, and investors are worried there's much more to come.
Shares of the two firms have been dropping for months as the housing downturn has worsened. This week's slide was sparked in part by a report from Lehman Brothers analyst Bruce W. Harting. He warned that a proposed accounting rule change would require the two companies to keep a lot more capital on hand. Fannie would have to add $46 billion to its reserves; Freddie would need to add $29 billion.
The large sums spooked investors, who worried about the firms' abilities to raise that kind of cash in the current tight credit market. And the sell-off began. Then later in the week, a former Federal Reserve governor, long a critic of Fannie and Freddie, said they were already insolvent, and he urged the government to take them over. Of course, if the government takes over, shareholders are likely to get nothing, so investors have been scrambling to sell their shares. Both stocks are at historic lows, with steep declines of more than 80 percent from a year ago.
Some analysts say a bailout is unlikely and that in any event, it shouldn't be hurried. They say there's still time for Fannie and Freddie to raise additional capital. Others say the time to act is now, before things get even worse.
Fannie and Freddie's role is particularly important nowadays: With the credit market drying up, the firms have often been the "buyer of last resort" for a mortgage at a time "when a broad-based buyers' strike threatened to paralyze the markets," Lehman Brothers' Harting writes in a research note. Any threat that they might fail, he says, "could trigger a meltdown in credit markets."
William Seidman adds that if the two firms' guarantee was considered "no good," it would result in "huge losses throughout the world" among financial systems that own their bonds and hold their guarantees.
If they went out of business, it would totally disorient the private housing markets, Seidman says. "It would be as close to a disaster as I can think of," he says. "If they could no longer package and guarantee mortgages, funding availability for housing in the United States would be drastically reduced."
The law that created Fannie and Freddie explicitly says the government does not guarantee the loans. But many government officials have said that Fannie and Freddie are too important to allow them to fail.
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Jeffery J. Smith runs the Forum on Geonomics.
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Also see: Subprime Loans, Subsidized Land, and Manipulated Money
Junk Economics -- O'Neill Slips, and Slips, and ...
The “Crash of 2007-8” is underway |
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