Sunday, August 22, 2010

Price Discovery In Housing Is Sorely Missing

This past week we had more of the same from Tim Geithner and Treasury about the state of Fannie & Freddie. We were told that what would be Fannie & Freddie's role with regards to housing finance. What we found out was Crony Capitalism along with government sponsored policies will not only prop up housing but the entire rotten to the core financial system for the foreseeable future. The main theme I was able to decipher was that both Fannie & Freddie are being enabled by the government, that these two government agencies are holding back the natural forces of supply and demand. For any market to work properly, proper risk management needs to be executed, you can only manage risk if there is proper price discovery. At the moment many are trying to figure out what are the true prices for houses? Guess what? They are still too high because these two agencies along with FHA seem to be the only game in town. They are artificially keeping prices high because that is in fact the government policy. Government policy from the beginning has been extend and pretend. Prop up the financial sector at the behest of the real economy. Keep insolvent zombie financial institutions around long enough so they can keep the casino open and running. We have seen nothing so far but handouts and bailouts with regards to the financial sector. From TARP, TLGP, HAMP, and now the unlimited checkbook for Fannie and Freddie. All of these various government programs only amount to back door bailouts for the banking sector.

The unwinding of the great credit bubble that fueled housing excess started in 2007, here we are a full 3 years later, with the SPX down over 40%, some 8MM jobs are gone, and we are no closer to actually finding a suitable solution to the housing situation. We keep hearing that if it wasn't for the government that housing would fall off of a cliff, that the economy will double dip. This is just the same old dumb rhetoric. Its counter factual. It is true that housing would plunge and take the economy with it. SO BE IT! Its already happening in front of our own eyes at the moment. Residential construction and housing became a bigger part of the economy than it ever should have, it needs to correct this excess.

Let me state this for the record. I DO NOT blame Fannie and Freddie for the credit/housing crisis. I DO NOT blame the Community Reinvestment ACT (CRA). They did not cause the economy to run off of a cliff. They were not even the primary reasons we had a credit bubble. There are so many reports, white papers, and essays from real smart (Non Partisan) level headed intellectuals that defend the CRA, and it should be defended. Its very easy to blame the poor as they don't have representation. Fannie and Freddie on the other hand didn't cause the crisis, but they did add fuel to the fire and will be the major predominate reason we have another relapse down leg in housing.

There are a many reasons we had a credit bubble. There are many reasons NOT TO BLAME FNE/FRE and CRA.  I can name a few:

-Total and complete abdication of lending standards
-Lend to securitize loan distribution model
-Total lack of regulation of non bank financial institutions
-The perversely absurd incentives given to every one up the loan supply chain
-The ultra low short rates set by the Federal Reserve Board
-Increase leverage by financial institutions
-Complex financial products that became toxic financial products
-Where was prudent risk management?
-Faith in unenlightened and busted financial theories and formula's
-Portfolio managers reaching and looking for yield enhancement
-Global savings glut as low rates were exporting inflation to Asia
-Credit Ratings Agencies selling AAA Ratings

OK. I am finished defending Fannie and Freddie. They were not the overwhelming reason for our economic ills, but they are currently the biggest impediment to a bottoming in housing and a sustainable recovery. The Treasury just seems to think that giving these two an open checkbook to continue to guarantee and originate loans is a plan to stabilize housing. This is just wrong. This only leads to further confusion. This only is an extend and pretend tactic by the government to buy the financial sector time. I am not stating that government sponsored housing should be stopped tomorrow, but a plan to eliminate them should be put into effect immediately. The more time, energy, and most importantly money is showered on these agencies, it just prolongs the inevitable.  Housing is going to correct. Its a mathematical certainty when looking at the foreclosure and delinquency rates. Nobody cares about how low mortgage rates are when housing is still some 25% overvalued, so we needed a plan from Treasury not the same old business as usual rhetoric.

This plan will allow the normal forces of supply and demand to take force. This will certainly lead to lower housing prices because there is far too much supply. One of the reasons most are not buying in spite of generationally low mortgage rates is most have no clue of what price discovery is. They know that housing is a black hole and that the government can't prop it up forever, so they are waiting for much lower prices. I am also not forgetting that loan standards have gotten tougher and of course the job picture is brutal at the moment. For the many who are fortunately employed, its a wait and see game. Many simply don't trust the government for good reason.

Last week we had this missive from PIMCO, the worlds largest bond manager.

Pimco's Gross Urges `Full Nationalization' of Housing Finance

Now, quite obviously PIMCO has some skin in this game. They must own tens of billions on mortgages. They only own these mortgages because they are 100% backstopped by the taxpayer. So what ever they say about this subject should be taken accordingly.

This is undeniably front running of housing public policy. That the US Economy can be saved only through "full nationalization" of the mortgage finance system is so out of whack with reality that its stunning. Its blatantly self serving. PIMCO is just another crony capitalist firm holding the entire economy hostage. These are the types of firms that have the ear of Treasury Secretary Tim Geithner.

The entire housing market at the moment is a mass delusion. Just 4 years ago all we heard was you have to be a homeowner. Home ownership is the American Dream. It is if you are employed by the financial sector as this puts the borrower in debt slavery. Home prices always go up. We know that all of this is false. The American Dream is getting a job not owning a home and making payments for the next 30 years. Fast forward to the present and we are no where close to fixing housing at the real economy level. The financial sector has used Fannie and Freddie as their personal dumping ground for crappy mortgages. Just like Goldman Sachs used AIG as their dumping ground for sub prime.  In both cases it was a toxic dumping ground. Who do you think is picking up the tab? We can move a little more closer to ending these types of practices but guess what? We need a plan and the only plan that Tim Geithner has is business as usual. Stay the course.

Where have we heard that before?

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