Rate Watch #759 We May No Longer Need FNMA & FHLMC

January 28, 2011
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

Analysis

It is worth noting that the idea that QE II has increased money supply is not quite accurate. What QE II has done is take the inflow of funds from the mortgages purchased by the Fed in 2009 and transferred it to Treasuries. Absent some sort of reinvestment,100% of the dollar inflow from these mortgage payments would decrease money supply. Some of this is P&I payments but a sizable amount last year was from payoffs of loans in the Fed portfolio in 2010 as rates bottomed. Those refinancings were not purchased by the Fed. The Fed's current MBS portfolio is about $262 billion less than it was when it peaked in April 2010. That is approximately what the Fed has pumped into Treasuries through POMO (Permanent Open Market Operations) since the start of QE II. What the Fed has done so far is prevent significant contraction of money supply. They have not yet increased it. If my ballpark calculations are accurate, at approximately the end of February QEII will actually have added more through POMO than the inflow from the Fed's MBS.

What is interesting is QEII has led to higher interest rates and also boosted the value of other asset classes such as equities. Perhaps this was their underlying intention. This pumping up of equity values has not been driven by money supply but by market psychology.

The State of the Union Speech addressed an issue of great concern to U.S. citizens - the national debt:

"It is my duty to recommend to your serious consideration those objects which by the Constitution are placed particularly within your sphere: the national debts and taxes... The consequences arising from the continual accumulation of public debts in other countries ought to admonish us to be careful to prevent their growth in our own."

- President John Adams, State of the Union 1797

What to Do with FNMA & FHLMC

We are coming up on the date on which, per Dodd-Frank, the government is supposed to decide what to do with FNMA & FHLMC. For me the answer is simple: we do not need these any longer. Allow a year for them to continue doing what they do but after a year let investment banks take over the securitization of all mortgages except VA and FHA. Let the GSEs exist to service the existing portfolios and perhaps sell their technology to any investment bank which wants it. I believe that the FNMA underwriting guidelines and its artificial intelligence underwriting are excellent and should be preserved. I see no defensible reason why the taxpayers should guarantee mortgage debt but I am willing accommodate VA and FHA. Less anyone imagine otherwise, the government should explicitly state that it is not guaranteeing any of the mortgages securitized by investment banks. Heck, let's make that a piece of paper in each loan file so that everyone knows.

This is not mere theory. If RPM has been able to securitize jumbo mortgages at rates which today are identical to high-balance GSE paper then I have to believe that this can be done. This notion that absent government guarantee mortgage rates would be 2% higher should now be relegated to the scrap heap. I grant that it could be possible that we are just fortunate at present with this pricing but this is real. It will take time to see how investors regard this debt.

FNMA & FHLMC were done in by HUD's mandate that they weaken their lending standards. Removing any government guarantee of mortgage debt (other than FHA and VA) would serve to minimize the damage that government could do in the future.

 

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Dick Lepre
RPM - SF
1400 Van Ness Avenue
San Francisco, CA 94109
DRE License # 01143973
NMLS Individual ID 302379
dicklepre@rpm-mtg.com
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 244-9383
(866) 488-2051 fax

California Department of Real Estate - real estate broker license #01201643