Fannie-Freddie II: The Wrath of Obama

So why did the Obama Administration last week increase the amount of Fannie Mae and Freddie Mac losses it would cover from the previous limit of $400 billion to the new limit of infinity? In the simplest terms, it was to reassure investors like China or Saudi Arabia who have bought or might buy in the future the securities of Fannie or Freddie. But among mortgage professionals I have spoken with, there is a general feeling, too, that the extra funds will be needed.

"They've been hiding losses as long as they can and will soon have to start taking them, " said one friend who has been in the mortgage business much of his life.

Remember that the amount of room left under the previous cap for guaranteed losses at Fannie and Freddie was $289 billion ($400 billion minus $111 billion already spent). The amount of Fannie and Freddie securities in the market totals about $5.5 trillion. So, for another $289 billion in loans to go sour, you'd need only 5.2 per cent of existing mortgages to fail. Right now, 4.7 percent of U.S. mortgages are in default, under foreclosure, or bank-owned. Most of those homes will be lost in the next 12 months.

So, it's a no-brainer to see that the existing cap of $400 billion was unlikely to stand. Absent any heroic moves on the part of the Obama Administration then, Fannie and Freddie are still in trouble -- big trouble -- and increasing the guarantee limit, no matter how politically it was timed, was probably inevitable.

That's the No Heroic Action scenario -- Fannie and Freddie take a big hit and lots more houses are lost.

But what if we are due a bit of heroism, what happens then?

This recession and recovery has been grossly unfair to homeowners. Of the approximately $1 trillion spent to date to overcome the mortgage crisis, less than three percent has gone to people who actually have mortgages. The rest was used to shore up banks, brokerage firms, and insurance companies -- to secure the structure of our financial world, if not to help the people who actually live in it -- us.

And the homeowners or would-be homeowners who have been helped so far, who are they? They are first-time homebuyers -- people who weren't in financial trouble for the most part. They are people who weren't behind in their mortgages and probably didn't need to be saved. The millions of folks who were in trouble generally still are. These people were offered a Federal mortgage modification program that had no real teeth to motivate lenders and is unlikely to help more than half a million of the four million homeowners who were targeted.

A vital thing to keep in mind about the Obama Administration's mortgage modification program is that its goal of four million modified mortgages was over two years. How the heck does that help the 4.7 million homeowners who will be out on the street six months from now?

It doesn't.

But there is an election coming and a Democratic majority thinking about self-preservation, so I am guessing we'll shortly see Fannie and Freddie take it on the chin through a new Federal program that will have the agencies absorb those infinite losses that are now guaranteed, without requiring the mortgage holders to lose their homes. Yes, a real bail-out of real people. Remember you heard it here first.

But one part of the market will still likely be missing from this new Federal program -- jumbo mortgages. So far none of the programs being offered have ever mentioned jumbos, which are mortgages generally $729,751 and above. That's because Jumbos are viewed as rich people's mortgages, and rich people are supposed to have all the money, right? Yet Moody's this month warned that $143 billion in jumbo mortgages are right now in danger of going-under -- none of those backed by Fannie or Freddie.

I predict the Obama Administration will bail-out their base and leave Jumbo mortgage-holders spinning slowly in the wind. Democrats have figured out that more of those Jumbo mortgages in trouble are held by Republicans than Democrats. Eventually those distressed Republicans are going to cry for help and their representatives will be forced to ask for what will be perceived as a rich people's bail-out. Since they can hardly do that and claim Obama is wrong to have helped others, there is a good chance this move will defuse the whole mortgage crisis in political terms, at least for the 2010 election cycle.

Clever guy, that Obama.

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