Forced Mortgage Refinance Does Not Create Wealth
Posted by Mark A. Calabria
The New York Times has gotten Washington all worked up with the suggestion that we can turn around both the economy and the housing market if only Fannie Mae and Freddie Mac gave all underwater borrowers an automatic reduction in their interest rate.
The thinking, as illustrated by that world class economist Matt Yglesais, is “with a lower monthly interest payment, an indebted household can pay down other debts more rapidly. A less-constrained household will increase its consumption of goods and services.” What this misses is that a mortgage is one person’s liability, but another person’s asset. By replacing a mortgage that yields 6% with a mortgage that yields, say, 4%, you decrease the value of that mortgage (or mortgage-backed security). So whatever increase in consumption you get from making the borrower better off is reduced by making the investor worse off. There’s no magic in wealth redistribution.
I’ve argued all this before, but the reality is that the push to give underwater borrowers a free re-finance is not about economics, it is about politics. Heading into the 2012 elections, this plan offers Obama the chance to give millions of borrowers (and voters) a freebie. Of course, it isn’t free. Even if the investor is the taxpayer, as in the case of Fannie and Freddie, it is simply a transfer from one set of taxpayers to another.
I was a little surprised, however, at Yglesais’s admission that he just discovered ” that Fannie & Freddie are overseen by an independent regulator.” That’s mortgage finance policy 101. But then why let any study of the facts or details get in the way of a good political giveaway.
What again is the great tragedy of borrowers being stuck with mortgage rates of 5.5 or 6.0 percent? Those are quite low by historical standards. And if the borrower wanted their rate to decline when overall rates decline, they should have taken out an adjustable rate mortgage.
Mark A. Calabria • August 25, 2011 @ 5:47 pm
cato-at-liberty.org
Obama Refinance Plan Sows Seeds for Another Bailout
Posted by Mark A. Calabria
I’ve already mentioned how the rumored Obama plan to re-finance existing underwater Fannie/Freddie loans with new mortgages at as low as 4 percent would not actually do much, if anything, positive for the economy. Even worse is that such a plan would likely require a massive infusion of taxpayer dollars into Fannie Mae and Freddie Mac.
First let us start with some basics about the Fannie Mae business. According to Fannie’s most recent 10-Q (see page 28), Fannie’s current interest-earning assets, mostly mortgages, yield the company 4.59%. However, Fannie has to fund those assets. The cost of Fannie’s total current interest-bearing funding is 3.99%, leaving the company a spread of 60 basis points to cover its non-interest expenses. What should be immediately obvious is that lowering the value of much of Fannie’s book to 4% will leave the companies with almost zero earnings. I’m not sure how that is supposed to get Fannie back on the path to repaying the taxpayer.
Worse is that newly re-financed 4% mortgages, or mortgage-backed securities, would remain on Fannie’s balance sheet for years (assuming Fannie is still around). I cannot be the only one who believes rates are going up in the future — either due to inflation or the Fed raising rates to fight inflation. It is not hard to imagine, in say two years, Fannie stuck with a balance sheet of 4% assets, while having to pay 5% to fund those assets. It is also not hard to believe that the taxpayer would get stuck making up the difference. On a $3 trillion balance sheet, that’s $30 billion. Add in Freddie and you’ll get another $20 billion or so. And that’s at future funding costs of 5%. If Fannie’s funding costs hit 6% in the next few years, we could be looking at an annual shortfall of $100 billion.
Instead of helping dig Fannie and Freddie into a deeper hole, Obama should start offering a real plan to help repay the taxpayer for what they’ve already had to shell out for Fannie and Freddie.
Mark A. Calabria • August 29, 2011 @ 8:47 am
cato-at-liberty.org |
