House Passes Legislation to Bailout Fannie, Freddie, Homeowners, Everyone

Landmark housing legislation sailed through the House today and is expected to pass through the Senate, bypass a Presidential veto and become law in a few days.  The bill amounts to a host of last minute measures cobbled together that throw money at several disparate housing problems.  The hope is that maybe one or two of them will actually solve a problem.  Most importantly, the bill gives Treasury Secretary Hank Paulson the power to inject capital into Fannie Mae and Freddie Mac and appoints a new regulator for the GSEs.  As I have noted before, I think it is appropriate for the Treasury to make their guarantee explicit given how the markets were in a complete panic a week ago.  A certain measure of confidence has been restored in the banking sector now that investors are less preoccupied with Fannie and Freddie's failure.  That confidence alone can ensure that the Treasury never has to inject capital.  Given their bloated balance sheets and huge amounts of leverage, Fannie and Freddie will need more capital if delinquencies and defaults rise (as they most certainly will given the absence of a bottom in housing).  But with a government guarantee in place, the firms will most likely be able to raise cash from the private sector.  Furthermore with a strict new regulator, theoretically we won't find ourselves in the same boat again.  I say "theoretically" because this is the Government we're talking about.  Lawmakers tried to appear as if they cared about limiting losses to taxpayers by tying any bailout of Fannie and Freddie to the federal debt limit.  Then they went and raised the debt ceiling by $800 billion.  

The portion of the bill that I am most skeptical of is the $300 billion Barney Frank brainchild that has been floating around for some time.  What Representative Frank proposes is that the FHA refinance up to $300 billion in mortgages of borrowers who cannot afford their current mortgage, into a more affordable mortgage.  Not only would the rate be lower but the principal would be reduced by a "significant amount," forcing the lenders to write down the value of the loan on their books, and extinguishing all second liens.  The borrower would then share in any appreciation in equity 50/50 with the government, assuming he lived in the house at least five years.  If he refinances or sells the property before five years, the government gets an even larger share of the equity (100% in the first year, 90% in the second, phasing by 10% until it hits 50%).  Presumably, if prices go lower, the homeowner will have all the incentive in the world to walk and leave the government with the bill.  There is no reason to believe that borrowers will default at a lower rate to the FHA than they would to a private mortgage lender.    

One major flaw in this bill is the idea that any American would give up his God given right to the equity in his home.  Owning a home in the US was touted for too long as the surest way to build wealth.  In parts of the country where home inventories are still very high and prices continue to drop, it seems unlikely that anyone would chose this option.  The logical choice would be to default, hand the keys back to the bank, go back to renting, wait 5 years or so for your credit to improve and buy another house where you get 100% of the equity.  While the bill claims that this will help 400,000 homeowners, my guess is that it will be far fewer than that.  You can read the rest of the 687 page document here if you're having trouble sleeping.  Trust me, it works.  I'm going to bed.