Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Stock Market: "Relevant Waves Vs. Irrelevant News" - 10th Jul 20
Prepare for the global impact of US COVID-19 resurgence - 10th Jul 20
Golds quick price move increases the odds of a correction - 10th Jul 20
Declaring Your Independence from Currency Debasement - 10th Jul 20
Tech Stocks Trending Towards the Quantum AI EXPLOSION! - 9th Jul 20
Gold and Silver Seasonal Trend Analysis - 9th Jul 20
Facebook and IBM Tech Stocks for Machine Learning Mega-Trend Investing 2020 - 9th Jul 20
LandRover Discovery Sport Service Blues, How Long Before Oil Change is Actually Due? - 9th Jul 20
Following the Gold Stock Leaders as the Fed Prints - 9th Jul 20
Gold RESET Breakout on 10 Reasons - 9th Jul 20
Fintech facilitating huge growth in online gambling - 9th Jul 20
Online Creative Software Development Service Conceptual Approach - 9th Jul 20
Coronavirus Pandemic UK and US Second Waves, and the Influenza Doomsday Scenario - 8th Jul 20
States “On the Cusp of Losing Control” and the Impact on the Economy - 8th Jul 20
Gold During Covid-19 Pandemic and Beyond - 8th Jul 20
UK Holidays 2020 - Driving on Cornwall's Narrow Roads to Bude Caravan Holiday Resort - 8th Jul 20
Five Reasons Covid Will Change SEO - 8th Jul 20
What Makes Internet Packages Different? - 8th Jul 20
Saudi Arabia Eyes Total Dominance In Oil And Gas Markets - 7th Jul 20
These Are the Times That Call for Gold - 7th Jul 20
A Reason to be "Extra-Attentive" to Stock Market Sentiment Measures - 7th Jul 20
The Beatings Will Continue Until the Economy Improves - 6th Jul 20
The Corona Economic Depression Is Here - 6th Jul 20
Stock Market Short-term Peaking - 6th Jul 20
Gold’s Major Reversal to Create the “Handle” - 5th July 20
Gold Market Manipulation And The Federal Reserve - 5th July 20
Overclockers UK Custom Build PC Review - 1. Ordering / Stock Issues - 5th July 20
How to Bond With Your Budgie / Parakeet With Morning Song and Dance - 5th July 20
Silver Price Trend Forecast Summer 2020 - 3rd Jul 20
Silver Market Is at a Critical Juncture - 3rd Jul 20
Gold Stocks Breakout Not Confirmed Yet - 3rd Jul 20
Coronavirus Strikes Back. But Force Is Strong With Gold - 3rd Jul 20
Stock Market Russell 2000 Gaps Present Real Targets - 3rd Jul 20
Johnson & Johnson (JNJ) Big Pharma Stock for Machine Learning Life Extension Investing - 2nd Jul 20
All Eyes on Markets to Get a Refreshed Outlook - 2nd Jul 20
The Darkening Clouds on the Stock Market S&P 500 Horizon - 2nd Jul 20
US Fourth Turning Reaches Boiling Point as America Bends its Knee - 2nd Jul 20
After 2nd Quarter Economic Carnage, the Quest for Philippine Recovery - 2nd Jul 20
Gold Completes Another Washout Rotation – Here We Go - 2nd Jul 20
Roosevelt 2.0 and ‘here, hold my beer' - 2nd Jul 20
U.S. Dollar: When Almost Everyone Is Bearish... - 1st Jul 20
Politicians Prepare New Money Drops as US Dollar Weakens - 1st Jul 20
Gold Stocks Still Undervalued - 1st Jul 20
High Premiums in Physical Gold Market: Scam or Supply Crisis? - 1st Jul 20
US Stock Markets Enter Parabolic Price Move - 1st Jul 20
In The Year 2025 If Fiat Currency Can Survive - 30th Jun 20
Gold Likes the IMF Predicting a Deeper Recession - 30th Jun 20
Silver Is Still Cheap For Now - 30th Jun 20
More Stock Market Selling Ahead - 30th Jun 20
Trending Ecommerce Sites in 2020 - 30th Jun 20
Stock Market S&P 500 Approaching the Precipice - 29th Jun 20
APPLE Tech Stock for Investing to Profit from the Machine Learning Mega trend - 29th Jun 20
Student / Gamer Custom System Build June 2020 Proving Impossible - Overclockers UK - 29th Jun 20
US Dollar with Ney and Gann Angles - 29th Jun 20
Europe's Banking Sector: When (and Why) the Rout Really Began - 29th Jun 20
Will People Accept Rampant Inflation? Hell, No! - 29th Jun 20
Gold & Silver Begin The Move To New All-Time Highs - 29th Jun 20
US Stock Market Enters Parabolic Price Move – Be Prepared - 29th Jun 20
Meet BlackRock, the New Great Vampire Squid - 28th Jun 20
Stock Market S&P 500 Approaching a Defining Moment - 28th Jun 20

Market Oracle FREE Newsletter

AI Stocks 2020-2035 15 Year Trend Forecast

Government is Setting Us Up for a Second Subprime Mortgage Financial Crisis

Housing-Market / Subprime Mortgage Risks Sep 23, 2009 - 06:39 AM GMT

By: Money_Morning

Housing-Market

Diamond Rated - Best Financial Markets Analysis ArticleShah Gilani writes: Is the government creating another subprime-mortgage bubble?

The first time around, the three-headed federal serpent - the Bush administration, the Treasury Department and the U.S. Federal Reserve - used Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) to "legitimize" trillions of dollars worth of toxic financial waste known as subprime mortgages.


The result was the worst financial crisis since the Great Depression - a mess that was global in nature.

And we're now headed for a repeat performance.

Some of the players may have changed since the first subprime-mortgage crisis, but the game apparently remains the same. With banks currently unwilling to lend, the new federal triumvirate of the Obama administration, the Treasury and the Fed are trying to inflate the moribund U.S. housing market. This time around, however, the FHA is the weapon of choice.

Obama & Co. are making an all-or-nothing bet that the U.S. economy will recover and bail out the housing market before the final bill for this ill-advised gambit comes due.

When this bubble bursts - and it will - U.S. taxpayers will be on the hook for more than $1 trillion in government-guaranteed debt.

Ginnie Mae: Fannie and Freddie's Once-Quiet Cousin

As a direct result of the real-estate meltdown, U.S. banks have become reluctant lenders. And they've raised their loan standards considerably. Federal officials knew they had to keep the mortgage spigot open, especially to suspect borrowers, so they turned to their new "secret weapon" - the FHA.

The FHA has been cranking out new government-insured subprime loans, which it packages into government guaranteed securities for sale to banks. This frightening reflation of the subprime bubble is being engineered for two key reasons:

  • To put a floor under falling house prices.
  • And to let banks swap toxic Fannie and Freddie securities for new toxic debt that is 100% guaranteed by U.S. taxpayers.

The almost inevitable insolvency of the FHA could rapidly undermine the fragile recovery of the U.S. economy. And it could plunge stock prices and bank viability to new lows.

Why the FHA? That's simple. In an era of increasingly stringent lending standards, the FHA's standards are laughably lax.

Created by the National Housing Act of 1934, the FHA insures private mortgage lenders against borrower default on residential real estate loans. But its current allure is that it opens the door to prospective homebuyers who almost certainly wouldn't qualify for a conventional home mortgage. These are buyers with no credit history, a history of credit problems, or not enough cash to cover the down payment and closing costs.

The FHA has quadrupled its insurance guarantees on mortgages in just the last three years, with the bulk of that growth coming in the past two years. Currently, the FHA insures $560 billion of mortgages.

Loans that are FHA-insured are pooled and packaged into mortgage-backed securities (MBS) by the Government National Mortgage Association, more commonly known as Ginnie Mae. Ginnie Mae insures the actual MBS pools composed of FHA loans. Ginnie Mae securities are the only mortgage-backed securities backed by the full faith and credit of the U.S. government.

Two weeks ago, Ginnie Mae proudly announced that it had issued a monthly record $43 billion in FHA mortgage-backed securities, and through the end of July held guaranteed securities with a value of $680 billion. It is on track to exceed $1 trillion worth of guaranteed securities by the end of calendar year 2010.

Ginnie Mae is a cousin of its better-known siblings Fannie Mae and Freddie Mac. Those two mortgage giants are technically insolvent, and were forced into government conservatorship at the height of the financial crisis - ostensibly due to concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds. As "government-sponsored enterprises," or GSEs, Fannie and Freddie were only supposed to have the "implicit" backing of the U.S. government. But recent events have shown these to be fully backed by taxpayers.

The implosion of Fannie and Freddie severely threatened the mortgage market. It essentially shut down the two giant repositories that bought the loans banks and mortgage originators didn't want to hold as assets on their own balance sheets.

The FHA and its mortgage-backed securities "factory" - Ginnie Mae - have taken up where Fannie and Freddie left off, and are now the dumping ground for toxic mortgages. Using the FHA is the core strategy in the administration's misguided effort to prop up mortgage origination and modifications, real estate prices and insolvent banks.

Warning Signals?

Administration officials might want to take heed of some eerie parallels between the current situation and the one involving Fannie and Freddie. They could serve as an early warning system.

First and foremost, the FHA has already started to acknowledge systemic fraud in its business. In the earlier subprime crisis, similar circumstances led to the revelation of massive fraud in the issuance, packaging, ratings and sale of subprime toxic mortgage-backed securities.

On Aug. 4, the FHA suspended Taylor, Bean & Whitaker Mortgage Corp., one of its largest approved independent mortgage originators, from making anymore FHA-backed loans. The suspension came one day after federal investigators raided Taylor Bean's Ocala, Fla., headquarters.

Since 2007, the value of FHA-backed loan originations underwritten by Taylor, Bean had soared 117%. By contrast, the origination of conventional loans by the firm dropped 34% over the same period. Taylor, Bean subsequently filed for bankruptcy.

Earlier this summer, the U.S. Department of Housing and Urban Development (HUD), which oversees the FHA, raised concerns about FHA practices. On June 18, HUD released an internal inspector general's report that revealed that the FHA's default rate exceeded 7% and that more than 13% of its insured loans were delinquent by more than 30 days.

In a "Review and Outlook" piece, The Wall Street Journal reported that the FHA's reserve fund dropped from 6.4% in 2007 to about 3% today, putting it dangerously close to its mandated 2% minimum. That translates to a "33-to-one leverage ratio, which is into Bear Stearns territory," the newspaper report stated, referring to the now-failed investment bank that had been a central player in the original subprime mortgage crisis.

Bear Stearns is now owned by JPMorgan Chase & Co. (NYSE: JPM).

The HUD inspector general's report stated that the agency's growth makes it "vulnerable to exploitation by fraud schemes" and that it may need "Congressional appropriation intervention."

In a recent article - "FHA Disputes Whispers of Capital Reserve Problems" - on the Mortgage News Daily Web site, HUD Secretary Shaun Donovan said in June that "there's a better than even chance that we will stay above the two percent reserve threshold. That suggests, not just for the 2010 business, but overall for the portfolio, that we'll more than likely to stay out of a broader need for any taxpayer funding."

It may be more than a little disheartening to know that in a very uncertain economic environment, precisely due to fraud in mortgage lending and increasing borrower defaults, that our government is stretching a 50/50 wager on the backs of taxpayers.

That's only part I of the FHA dilemma story.

Part II is even more frightening.

A Look Ahead

Banks are dumping Fannie and Freddie-backed securities onto the Fed's balance sheet and replacing them on their own balance sheets with FHA-insured loans packaged into government-insured securities issued by Ginnie Mae. Banks aren't reducing their net assets, they are aggressively swapping acknowledged toxic securities that no-one wants for a new variety that no one will want in the future. Why?

It's not just that Ginnie Maes are fully backed by the U.S. taxpayers and Fannie and Freddie's securities are only implicitly backed. All of them will be covered by taxpayers.

The devil is in the details.

Because Fannie and Freddie securities are only implicitly guaranteed, banks that hold these securities as assets on their balance sheets must "haircut," or set aside reserves, based on a 20% risk-weighting assigned to the value of those holdings.

Because Ginnie Maes are explicitly 100% guaranteed, they are considered "risk free," and on par with U.S. Treasury bonds, notes and bills. There is no reserve requirement, or haircut, on Ginnie Mae securities.

By replacing their asset mix and holding Ginnie Maes, banks don't have to set aside reserves. They can use the money they otherwise would have to set aside to actually leverage-up their balance sheets. And guess what they're buying?

More Ginnie Maes, naturally.

The effect of the asset swap - basically one toxic pool for a replacement that's not much better - creates the illusion that banks have healthier balance sheets and that they are meeting their reserve requirements. It's such a good deal for the banks and actively promoted by the Fed and Treasury, that banks are using Troubled Assets Relief Program (TARP) money to buy Ginnie Maes.

But it's all a fa�ade.

Capital ratios are being manipulated and insolvent banks are being propped up.

The danger of relying on the FHA to prop up the shaky housing market by facilitating mortgage origination, modifications and refinancing to less-than-stellar borrowers will only result in more subprime loans being stockpiled on the Federal Reserve balance sheet.

Eventually, defaults will overwhelm the FHA. And the hoped-for floor in residential real estate pricing will be pulled out from under us all. The next down-round in real-estate values will expose bank balance sheets for what they really are: Over-leveraged and over-stuffed with junk. Already on the ropes, banks will lose capital and will have to tighten the credit screws on consumer borrowers even more.

We may be headed for another bruising round of real-estate and MBS-related depreciation. Even a mild financial-markets setback could put the economy and the stock market onto the canvas for a 10-count. Further pummelling of shaky consumer confidence accompanied by a couple of major bank failures could easily send the U.S. market down for the financial-system equivalent of a TKO.

Taxpayers, always the lowly cornermen holding the spit buckets, are already in place with the safety nets. We will catch the FHA loans because we insure private lenders against subprime borrowers with no skin in the game. We then will have to catch the buyers of Ginnie Maes, because we guarantee those MBS securities. And we will be forced to catch the falling banks, because we already insure depositors through the Federal Deposit Insurance Corp. (FDIC).

Perhaps our ultimate fate is that of the permanently punchdrunk veteran boxer, who rues his decision to stay in the game, realizing that he fought "one bout too many." If that's the case, that "one bout too many" could be Subprime Crisis II, arranged by the very market referees whose job it was to protect us from such beatings.

Time for the Panda-Bashers to Shut the "H" Up!

Their rank ignorance has already cost investors 43 opportunities to double their money. This loud-mouth army of nay-sayers has completely missed the real secret of making money in China. And they're about to ignore potential gains of 600%... 341.6%...334.1% in the months ahead. Investing legend Mark Mobius says "...China must be an investment destination for any intelligent investor." What is it these dunces don�t understand... and how can you use their folly to make money? Find out here.

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules