So few commentators have made this point..... indeed, I think I was the only one. Let's revisit the FOMC statement:
To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.
In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.
That's the key part of the statement: it is a warning to The Administration and Treasury.
What I said yesterday was:
We bought it all. We're no longer part of the market, we are the market! We have no freaking clue how to exit from this, and we know that when we do rates will spike higher. Unfortunately we also know that if Fannie and Freddie continue to bleed red ink we will blow up instead of them by doing this, so in March we pinky-promise to stop, even though that will destroy what's left of the housing market.
Read that again.
Now consider this:
The Federal Housing Administration abruptly delayed the release of a long-awaited independent audit of the financial soundness of the agency, citing potential problems with the accuracy of some of the study's economic models.
Economic models eh? You mean an institution that is levered 50:1 (which the FHA currently is, if I'm doing the math right) could have a wee problem should something go wrong? What could go wrong? Oh, maybe things like this:
Most banks rejected Ms. DeForte because her debt level was too high and her credit score too low. But Lend America put Ms. DeForte into a $402,000 loan backed by the Federal Housing Administration, a New Deal-era agency that Washington and Wall Street were relying upon to pick up the slack in the mortgage market as private lenders pulled back. Ms. DeForte fell behind on payments six months later and is seeking a loan modification. Taking the loan was "a stupid mistake," the 46-year-old office manager said.
It may have been a stupid mistake but the principle of asymmetric information meant that the FHA knew damn well what it was doing, and did it anyway. Ms. DeForte might not have understood it at the time (and now recognizes that it was a stupid mistake), but both Lend America and The FHA don't have that excuse.
Indeed, as I've documented, the FHA has been willing to write paper with their guarantee on loans with DTIs (debt-to-income) ratios exceeding 50%!
Congress is barking but has yet to bite:
"If not addressed promptly, problems at the FHA may result in yet another massive taxpayer-funded bailout that this country cannot afford and which the American people will not accept," wrote Republicans Darrell Issa of California and Spencer Bachus of Alabama in a letter, released Wednesday, to Housing and Urban Development Secretary Shaun Donovan.
Really?
I love 'ya Darrell, but neither you or anyone else on Capitol Hill have done a damn thing about Fraudie and Phoney! Indeed, close to $100 billion in taxpayer funds have been larded into those institutions to prevent their utter collapse but the bogus lending has simply shifted as a matter of formal policy over to the FHA, which is then selling the paper back into - you guessed it - Fannie and Freddie!
Fraudie and Phoney are not new to trouble. Documents from 2004 show that the "massage the earnings" game was well-embedded into these institutions as early as 2001, yet nothing was done.
Seven years later, the taxpayers are on the hook for $100 billion, the firm's capital continues to erode as their default rate skyrockets by the month and yet not one of the people responsible is sitting in the dock - or in a prison cell.
The Federal Reserve's statement is, I believe, a clear statement and warning to the Congress and Treasury: Figure out what to do with these two firms, and do it, prior to the end of the first quarter of 2010, or we will cut them off and stand back, as we're not going to be the one holding the grenade when it goes off.
The reason for the warning should be clear - FHA may be writing the insurance on these notes but most of them are being foisted off on Fannie and Freddie. Rather than solving the problem we have Barney Frank making public statements that intentionally making bad loans is a policy - when The Fed is the one buying the paper generated by those bad loans!
The proper Congressional role of regulation - that is, write laws which The President then signs - has been perverted by a Federal Reserve that has had two successive chairmen who have "knelt before Zod" and performed an obscene act - with Zod residing both in Congress and Wall Street. This was all in the name of "economic stability", but now it threatens The Fed itself.
Consider that The Fed will have over one trillion dollars of potential putrid trash on its balance sheet by next spring. MBS and Debt that have no formal guarantee from The Federal Government, contrary to the strictures on Fed ownership embodied in the black-letter law of Section 14 of The Federal Reserve Act.
The "detonation risk" on these securities is very real, and when one considers that said securities will back more than half of the reserves in the system under Fed control, this should be keeping Bernanke and company up at night.
The Fed has in fact been the handmaiden of both Congress and Treasury through this entire mess. Under the guise of "systemic risk" The Fed has monetized over a trillion dollars of debt for the explicit purpose of bailing out the outrageous actions of both Wall Street and Congress. But unlike the relatively small exposure of Maiden Lane I-III, totaling some $60 billion, the outrageously bogus lending practices ensconced in Fannie, Freddie and the FHA have exposed The Fed to well over $1 trillion of garbage paper.
Congressfolk must zip up and get to work, for The Fed has made a clear statement that it will not be coming back to kneel shortly.
Fannie and Freddie must be wound down. Whether Congress likes it or not, mortgage lending must return to sound principles - 20% down payments, 36% back end ratios - period. It must become reasonably safe and profitable to portfolio loans - not play "hot potato" with them so as to generate nothing other than fee income, relying on that for profit instead of making sound lending decisions.
Yes, this means interest rates will rise to a market rate.
We have spent more than two years trying to avoid recognition of fundamental mathematical facts - average home prices cannot exceed 3x average incomes, and on balance home prices cannot rise faster than income over long periods of time.
Mean-reversion isn't a suggestion, it is a mathematical reality. As a homeowner with a fully-paid-off house, bought with cash, I certainly would prefer my home to have a value closer to 2005's price than 1995's.
But what I prefer has nothing to do with what is mathematically sustainable or what can be supported by the broader economy, and my personal desire to be able to "flip" my house or use phantom "wealth" to extract a lifestyle I cannot afford does not and cannot change the reality of what stability in the economy, on balance, requires over the intermediate and longer term.
Property prices must contract to sustainable values. If this causes banks to fail, so be it. If this causes consumer bankruptcies for those who used their homes as ATM machines, so be it. If this causes me to lose half of the "value" in my home, so be it.
I believe The Fed sent a message to Congress yesterday in recognition that the wall is fast approaching at 120mph: do the right thing and do it now - or else.
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