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Best Economic Policy: Allow Real Estate To Correct

US Economic Policy has always been to artificially increase prices in an attempt to avoid dealing with the consequences of economic recessions. Both the US Government and the quasi-private Federal Reserve have done so with their anti-free market interventionist policies. For many decades now the economic growth of the US has been dependent on Government deficit spending to finance the costly Big Government policies that subsidize economic activity. Doing so we have avoided many significant economic contractions at the cost of record deficit spending and the loss of a fundamentally sound economy. In order to fight contractions in the housing market both the Federal Government and the Federal Reserve System implement many policies that protect the housing and financial markets from natural economic contractions.

Demand and Supply of Real Estate

Any natural reduction in demand for real estate is quickly fought with the expansion of anti-free market policies that create artificial demand for housing while restricting the supply. In addition to artificial low interest rates, the systematic expansion of government loan guarantees increases the demand for real estate while policies that led to an unofficial foreclosure moratorium restrict supply. The interventionist policies affecting the real estate markets result in artificially high prices that are very disconnected from economic fundamentals. It doesn’t make financial sense to buy overpriced residential real estate just as it is impractical for businesses to incur the elevated cost of doing business in the United States with expensive American labor.

Real Estate Correction Will Help Create Productive Manufacturing Jobs

The American unemployment rate is greater than it has been for many decades. American Companies have outsourced many productive jobs to foreign Nations where commercial real estate and labor are more affordable. These jobs will never return to the United States unless this Nation is willing to provide a more competitive business environment. It is unrealistic to expect that these jobs will return to the United States with salaries that support the current artificial high costs of living. It is therefore economically damaging to implement policies that subsidize real estate and increase the cost of living. In order to create jobs we must be competitive and the only way to do so is by allowing the markets to be free and competitive on all levels. A competitive business environment cannot exist as long as we have excessive regulation and market manipulation in the real estate sector. By removing regulations jobs would return but the American workforce would have to adapt to a more competitive salaries which would not allow them to afford the current artificial high cost of living that is subsidized through market manipulation. Unless the United States is willing to cease its interference in the market place and allow real estate to correct there is no chance that we will see a fundamental economic recovery. It is therefore imperative to allow Real Estate to correct by ending the non-sense costly market manipulation which only ensures artificial high price stability and dependence on Government.

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Fannie Mae Bailout Continues

Fannie Mae, the Government Sponsored Enterprise that guarantees home mortgages, is seeking its next round of government bailout funds. Fannie Mae reported its financial earnings statement on August 5, 2011, reporting a loss of $2.9 billion for its second quarter. In the first quater of 2011 Fannie Mae lost $6.3 billion.

From the Fannie Mae Financial Statement:

“Our net loss and total comprehensive loss for the second quarter of 2011 were both $2.9 billion. In comparison, we recognized a total comprehensive loss of $6.3 billion in the first quarter of 2011, consisting of a net loss of $6.5 billion and other comprehensive income of $181 million. We recognized total comprehensive income of $447 million in the second quarter of 2010, consisting of a net loss of $1.2 billion and other comprehensive income of $1.7 billion (primarily driven by a reduction in our unrealized losses due to significantly improved fair value of available-for-sale securities).”

The government loan gurantees through Fannie Mae and Freddie Mac greatly contributed to the artificial low interest rates which were a significant contributing variable that made the housing bubble possible. These reported losses are greatly understated as Fannie Mae and the financial industry in general are allowed to use Enron type accounting evaluations since the change away from mark to market accounting in Spring 2009. Without marking its assets up to bubble values the losses of Fannie Mae would be multiples greater.

According to Reuters, Fannie Mae asked the Government for an additional $5.1 billion in bailout funds. The additional bailouts is needed as Fannie Mae continues with non-sense business practices in order to price fix Real Estate values, provide bailouts to individuals and banks, while continuing to provide artificial cheap financing to borrowers that wouldn’t qualify without the Government as guarantor. This socialized credit subsidy has been supported by the majority of Democrats and Republicans while free market proponents warned of the costly consequences.

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Ron Paul Forecasts the Housing Bubble in 2002

While Democrats and Republicans welcomed big government policies that subsidize the real estate market, Congressman Ron Paul warned about the dire consequences of such interventionist anti-free market policies.

In response to the expansion of the FHA program that President Bush announced, Ron Paul addressed the House on July 16, 2002 with a speech where he proposed his pro-free market approach to housing and credit.

“Mr. Speaker, I rise to introduce the Free Housing Market Enhancement Act. This legislation restores a free market in housing by repealing special privileges for housing-related government sponsored enterprises (GSEs). These entities are the Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB).

One of the major government privileges granted these GSEs is a line of credit to the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out these GSEs in times of economic difficulty helps them attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a massive unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing.

Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.”

Neither the House Financial Services Committee nor its Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises felt that Ron Paul’s wisdom deserved further attention or a vote. While Ron Paul has been on record warning about the consequences of interventionist government policies that distort market dynamics, Big Government proponents in both parties have voted for endless bills that grow the role, size, and control of the Federal Government. The result of such policies are greater powers to interfere with and subsidize the real estate, credit, and equities markets.

Congressman Paul ends his speech with a hypothetical forecast of how the Federal Reserve might react once the Real Estate bubble bursts.

“Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

Mr. Speaker, it is time for Congress to act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors misled by foolish government interference in the market. I therefore hope my colleagues will stand up for American taxpayers and investors by cosponsoring the Free Housing Market Enhancement Act.”

Unfortunately not much has changed and the people who warned about the Big Government policies that will lead to the housing bubble are ignored while the politicians who voted to get us here are now given center stage for their solutions.

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Why Did The Housing Market Crash?

Why did the Housing Market Crash? There are many people who are asking this question and most of them did not recognize the irrationality during the housing bubble nor had the foresight that the housing bubble would collapse. Most people didn’t acknowledge that we had a bubble and still fail to understand that we continue to have an artificial Real Estate market that is overvalued for the very same reasons that caused the housing bubble to inflate. An asset class can still be artificially overpriced despite having dropped from its all time high. Instead of asking why the housing market crashed, it is much more valuable to ask the question of what created the housing bubble in the first place. To financial historians not surprising, the very variables that made the housing bubble possible are now part of the solution to “fix” the real estate market. More anti-free market policies, more Government interference to continue distorting the markets…

Contrary to the misconception that it was the free market that made the housing bubble possible it was interference in the market place that distorted the demand and supply variables for credit and real estate. The Federal Reserve greatly distorts the supply and availability of money with its anti-free market loose interest rate manipulation. The Government also interferes in the market place with non-sense guarantees of home loans made through Fannie Mae, Freddie Mac, USDA, and VA.

In a free market system the cost for credit is dictated by the market forces that consist of the relationship between the demand for credit and the availability of savings to be lent. In addition to this demand and supply relationship the lender charges a risk premium to the interest rate for the loan. In times when the savings rate is high, interest rates would come down as much money is available to be lent. On the contrary, during periods when people save little the cost for credit would go up as the availability of savings to be lent is scarce. This would also encourage saving in times when the National savings rate is low, while a low cost for borrowing would naturally encourage people to borrow money for investments and consumption during times of high savings.

It wasn’t the free market that encouraged malinvestment and speculation. It was the Government guaranteeing home loans through various agencies such as Fannie Mae and Freddie Mac that eliminated risk as the lender would have the ability to make loans while the Government guaranteed its potential losses. As such there was no incentive to lend money conservatively as doing so would restrict the number of transactions while not minimizing potential losses since these losses were absent due to the Government guarantees. To make matters worse, Republicans and Democrats alike voted several times to increase the FHA loan limit during the housing bubble. This allowed people to take on greater debt and perfectly illustrates that government subsidies do not lower the price but make the underlying assets more costly. By raising the FHA loan limits the Bureaucrats in Washington voted to extend the housing bubble, raise prices, and delay the inevitable correction.

While many self-proclaimed conservatives blame the Democrats for the social programs and anti-free market policies it was President Bush in 2002 who stated that a high down payments are a big barrier to first time owners. During “A Home Of Your Own” conference on May 17, 2002 President Bush urged Congress to use taxpayers money to interfere in the market place by lowering down payments for those that cannot afford to buy a home. During that speech President Bush also explained how the guarantees of home loans by the Government Sponsored Enterprises would streamline the underwriting process and basically neglect the risk variable. President Bush made it clear that his and Congress’ vision is to make homeownership a right and not a privilege.

“A third major barrier is the complexity and difficulty of the home buying process. There’s a lot of fine print on these forms and it bothers people, it makes them nervous…and so therefore what Mel [previous HUD Secretary] has agreed to do, and what Alfonso Jackson [current HUD Secretary] have agreed to do is to streamline the process, make rules simpler so that everybody understands what they are, makes the closing much less complicated. We certainly don’t want there to be a fine print to prevent people from owning their home. We can change the print….that will have a powerful impact…”

This type of market interference in addition to the Federal Reserve manipulating short term rates to historic lows greatly increased the demand for housing and extended cheap credit to people that otherwise wouldn’t have qualified. It wasn’t the free market that encouraged malinvestment and led to financially flawed business decisions. It was a continuation and expansion of big government policies, brought to us by both Democrats and Republicans. The Fed’s loose monetary policy with artificial low interest rates in combination with socialist and corporatist housing policies by the Government provided the foundation for the biggest housing bubble in history.

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Proposed Mortgage Reform

U.S. Bank regulators are proposing guidelines and new rules in the mortgage market to reform the industry that collapsed in recent years. Bank regulators endorsed a proposal that would require a 20% down payment on a mortgage if the lender wants to repackage the loan to resell the security on the secondary market without keeping some of the risk.

With the intention of forcing lenders to have “skin in the game” big government proponents are working on rules that would further interfere in the market place. Ironically, it has been proposed that loans made through Fannie and Freddie would be exempt from such risk retention as long as those entities remain under the conservatorship of the government.

WTF Finance does not believe that the Government should interfere in the credit markets. As we pointed out in our article “Government Solution For Phasing Government Out Of Housing Market: More Governmentit was the Governments role as guarantor that led to loose credit and lending to unqualified borrowers. The same people who voted to expand the taxpayer liability through an increase in FHA loan limits, by providing up to 125% LTV financing through FHA, USDA, and VA are now calling for tighter lending standards for financial institutions while excluding those same agencies from the requirements.

It is widely accepted that without the Government, there would be no floor under the housing market, demand at current prices would have dried up, and inventories would flood the market pushing prices down to affordable levels. In an interview with CNBC, Toll Brothers CEO Douglas Yearley Jr. said:

“There’s no question if the government gets out of the business of backing mortgages, rates should go up, underwriting will be tougher, down payments will go up… It’s going to affect all of us. It would be a head wind.”

While this is true and the result would be a further depreciation of real estate values, the only way to correct this bubble is to let it deflate. Increasing regulation on private lenders does not solve the problem especially when the programs and institutions that are mostly responsible for the bubble are not obligated to abide by the regulations. All that is necessary is for the government to eliminate all programs that distort the housing market and credit dynamics. Abolish the Federal Reserve and let the free market set interest rates to reflect real supply and demand for credit, including risk. Let the free market decide who can qualify for a mortgage and at what terns and most importantly let those who make unsound business decisions fail. The Government should not subsidize cheap credit, set loan terms through regulations and it isn’t the Government’s job to bail out the irresponsible. If we had a free market with financial Darwinism the U.S. Economy would be in much greater shape.

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FDIC Sues Former WaMu Executives For Negligence

The Federal Deposit Insurance Corporation (FDIC) sued three former executives of Washington Mutual, the bank that failed and was taken over by the FDIC in 2008. Assets of WaMu were sold Chase at favorable terms as liabilities were retained by the Government. The bank failure of Washington Mutual marked the biggest bank failure in U.S. history to date.

The FDIC accuses former CEO Kerry Killinger, former COO Stephen Rotella and former president of the home loan’s division David Schneider of gross negligence in making billions of dollars in questionable home loans. The case being made is based on the excessive lending and loose qualification standards leading up to the housing bubble bursting.

Among the many complaints against WaMu, the FDIC cites option ARMs, negative amortization loans, subprime lending, home equity loans and high loan to value products as the reasons for its high risk lending portfolio collapsing. While WTF Finance agrees that some of these factors contributed to and perpetuated the housing bubble, we disagree that this was exclusively a WaMu issue.

With GSE guarantees, banks did not have to worry about the creditworthiness of borrowers as those loans were guaranteed by the Government putting the burden on taxpayers. With FHA consistently increasing the mortgage guarantee limits, banks were not incentivized to perform their due diligence. If a mortgage is guaranteed, and the deposits which are leveraged in order to issue that mortgage are also guaranteed, what possible motive would there be to be diligent with issuing credit?

This frivolous lawsuit seeking damages of around $900 million will be settled out of court like Bank of America and Citi et al. before it. When will the FDIC get around to suing the Government for gross negligence for putting the taxpayers on the hook to cover trillions of dollars in home loans that are now non-performing underwater “assets” waiting to be written down? When will the FDIC conduct an internal investigation for its lack of business sense as this government “insurance” program is on lifeline through a credit line issued by the Treasury?


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The FHA Bailout for Banks: New Government Guarantees By Expansion of FHA Loan Modifications

WTF Finance reported how the proposed solutions for dismantling Fannie Mae and Freddie Mac involve more Government. The two Government Sponsored Enterprises guaranteed trillions of mortgage debt and were bailed out by the U.S Government while continuing to guarantee non-sense loans making up most of the lending environment post-Real Estate bubble implosion.

In August 2010 the U.S. Department of Housing and Urban Development (HUD) announced a new program that would be implemented to help the responsible homeowners that did not fall behind on their mortgage. The NY Times now reports how a significant number of lenders have signed up for this program.

“Six months after the Federal Housing Administration announced an $11 billion refinancing initiative for these “underwater” borrowers, nearly two dozen lenders have agreed to take part in a new loan modification program.

To qualify, homeowners must be current on their monthly mortgage payments and not already have an F.H.A. loan. The size of the new primary loan cannot be more than 97.75 percent of the current value of the property; refinanced loans for homeowners whose properties carry second liens cannot exceed 15 percent of the property value.”

According to the official HUD announcement the qualification criteria are:

HUD logoThe FHA Short Refinance option is targeted to help people who owe more on their mortgage than their home is worth – or ‘underwater’ – because their local markets saw large declines in home values. Originally announced in March, these changes and other programs that have been put in place will help the Administration meet its goal of stabilizing housing markets by offering a second chance to up to 3 to 4 million struggling homeowners through the end of 2012.”

According to the NY Times article participating banks in the FHA Short Refi Program include: Wells Fargo, Ally Financial (formerly known as GMAC), Wall Street Mortgage Bankers of Lake Success, NY; 1st Alliance Lending of East Hartford, CT.; Nationstar Mortgage of Lewisville, TX.; E Mortgage Management of Haddon Township, NJ.; and Glacier Bank of Kalispell, MT. 23 more lenders have signed up for the program according to HUD that estimates that approximately 500,000 to 1.5 million homeowners can benefit from the program.

This program illustrates that the Government has absolutely no plans or intention to exit the credit markets and reduce its guarantees on home loans. This week Treasury Secretary Geithner stated before the House Committee on Financial Services that he wants to reform and reduce the role of Government involvement in the credit market and allow for the private lending to make up a majority of real estate lending.

“The Administration is committed to a system in which the private market – subject to strong oversight and strong consumer and investor protections – is the primary source of mortgage credit.”

WTF Finance would like to point out that these promises are merely promises to please international investors and provide them with misplaced confidence that the United States is addressing the root of our economic problems and therefore can balance its budget in the future. This HUD program is an expansion of FHA guarantees. The U.S. is not serious about changing its involvement in the credit markets as it otherwise would not have continued to guarantee non-sense loans that no private entity would have made. To give banks the option to take a modest 10% loss on their non-guaranteed underwater mortgages in exchange for Government guarantees on future losses that could far exceed the 10% write down is all but a sign that the Government is willing to exit the credit markets. This is an insurance policy whereas the banks don’t pay the FHA any insurance premium.

The smaller banks that are accepting to take the 10% write downs are making themselves more attractive to a future takeover from a large financial institution as their loan portfolio is now guaranteed.

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Alan Greenspan: Monetary Policy, Deficit Spending, And Future Inflation

Former Federal Chairman Alan Greenspan was hosted on CNBC answering questions about monetary policy and his views on the current state of the U.S Economy. WTF Finance is a harsh critique of Alan Greenspan as the policies of the Federal Reserve were interfering with the natural demand and supply variables of the markets. Greenspan “solved” economic recessions by infusing trillions of newly created liquidity into the markets while keeping interest rates at artificial lows, fueling the speculation in the stock and real estate markets.

“The Fed does do look at future inflation…. It can look at future inflation just as well as he can, not any better, not any worse”

Greenspan acknowledged the budget problems and rightfully questioned equity prices while also voicing concern about the deficit spending and the loose monetary policy. Interesting given that this is descriptive of the policies of the Federal Reserve while Greenspan himself was head of the quasi-private Federal Reserve Bank.

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Treasury Secretary Timothy Geithner Before The House Financial Services Committee

The supply and demand variables for Real Estate were greatly distorted by interventionist policies of the Federal Government and the Federal Reserve System. Guarantees for mortgages through FHA, Fannie Mae, Freddie Mac, VA, and USDA not only put the Nation at increased risk of future deficit spending as a direct result of potential loan losses, but artificially increased demand which was a significant contributor to the real estate bubble.

As WTF Finance already reported in its article “Government Solution For Phasing Government Out of Housing Market: More Government” it becomes obvious that nobody is willing to allow the market to function.

Geithner completely misses the point:

“We did not do a good job in helping low income Americans get access to sustainable housing finance options; we left them with a system where it was easy for them to be taken advantage of.”

Nobody lost anything by being “taken advantage of”. Any Real Estate purchase is made by two parties agreeing on the terms. If you opted for an interest only loan, adjustable rate mortgage, or lied to overstate your income it was with your consent. Further, the so called “taken advance of homeowner” enjoyed a lifestyle they couldn’t afford. How is that being taken advantage of? Not only did they buy Real Estate they couldn’t afford through Government subsidies but enjoyed tax deductions and home equity refinance money in the process. WTF Finance would make the point that those people were hardly taken advantage of and didn’t lose anything. If anything, those people took advantage of the system and the loan terms made available to them by Government and Federal Reserve interference. With nearly 100% more, those people didn’t lose any savings. In the event of foreclosure they still could live several months if not years without having to pay a mortgage. Anybody that is a renter would be evicted within a few weeks of missing a rental payment.

Geithner further stated:

“Under any of these options [Fannie and Freddie reform] we want to make sure that the FHA is able to play the very important role of making sure that Americans with low to moderate incomes can have the opportunity to get a government-guaranteed mortgage with a very modest down payment.”

In other words, we will continue putting the liability on the tax payer in order to subsidize non-sense real estate loans that ensure that we have artificial demand that supports artificial high real estate prices.

If anybody wants to truly help the low income and those that are fiscally responsible they would stop interfering in the housing and credit markets which would allow home prices to significantly drop to affordable levels that are supported by sound fundamentals. Government subsidies do not make housing more affordable but have the exact opposite effect.

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More Losses For Fannie And Freddie: How Much Will It Cost Taxpayers?

The two Government Sponsored Enterprises Fannie Mae and Freddie Mac reported billions in losses for the last quarter of 2010. Fannie Mae lost $2.1 billion for the October – December period while Freddie Mac lost $1.7 billion. Both entities lost less than last year during the same period yet had to request additional government funds.

Freddie increased its previous request from $100 million to $500 million while Fannie Mae increased its request by an additional $100 million to $2.6 billion in additional help from the Government for their loan losses. The two entities guaranteed nearly half of all US home loans.

Yahoo Finance reports:

“Washington-based Fannie Mae and McLean, Va.-based Freddie Mac own or guarantee about half of all mortgages in the U.S., or nearly 31 million home loans worth more than $5 trillion. Along with other federal agencies, they played some part in almost 90 percent of new mortgages over the past year.

The two have been hit by massive losses on risky mortgages purchased from 2005 through 2008. The companies have tightened their lending standards after those loans started to go bad. Default rates on new loans are far lower.”

WTF Finance would like to point out that the Government, through these two entities, still guarantees 96.5% financing which is all but an improvement, especially considering that a significant amount of loans made post sub-prime collapse are already in default. On March 23, 2010, the Washington Post reported:

About 4.8 percent of FHA-backed loans made in the two years ended Feb. 28 were at least three months late, down from 5 percent in the two-year period ended Jan. 31, according to the agency’s most recent public data. About 154,000 loans were seriously behind and another 8,500 had gone bad, requiring the agency to pay claims to lenders.

One can hardly make the point that those in charge did their due diligence and acted in the best business interest when underwriting and guaranteeing those loans. The fact that Government subsidized home loans make up 90% of the mortgage market over the past two years should be an indication that it doesn’t make financial sense to continue lending at these artificial loose terms. A default rate of 4.8% is certainly an improvement but it should be noted that many socialist bailout programs were implemented that helped lower that rate. In summary, nothing has changed when it comes to the Government guaranteeing non-sense home loans as we reported in our article “Inside The Bubble Economy”.

The general consensus is that the bailout of Fannie and Freddie will cost taxpayers as much as $259 billion which is greater than originally expected. WTF Finance believes that $259 billion still greatly understates the true cost of the Fannie and Freddie bailout. There are many interventionist bailout programs in place that artificially lower the foreclosure and delinquency rates. They do so through modifications of the loan terms or by allowing the homeowner to live mortgage free for several years. Without all the anti-free market bailout programs the foreclosure rate would be multiples greater and it is therefore unrealistic to state that Fannie and Freddie only cost a quarter trillion dollars in bailout funds.

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