When is enough, enough?

When is enough, enough? How much is too much?

Those are the questions I’ve been pondering lately as I survey the housing and mortgage market landscape.

It seems like every week we get another borrower bailout initiative.

Or another multi-billion dollar package of legislation.

Or another whiz-bang Federal Reserve program that keeps U.S. banks and brokers on the dole for a few more months.

Or more recently, a blatantly transparent attempt by the Securities and Exchange Commission to squeeze short-sellers and drive stock prices higher … but only for a select group of 19 financial companies.

Are we a free market society? Is this a capitalist economy? I thought so.

But with each extra step to prevent the failure of a lender who made too many stupid decisions … with every effort to keep borrowers who overextended themselves on home mortgages … and with every move to prevent what NEEDS to happen to restore health in the housing market — namely, falling home prices — I wonder that much more.

And I’m afraid the long-term consequences of all these bailouts will be severe. So today, I want to examine how we got here — and talk about where we’re going …

The Fed Shifts into Hyperdrive …

The credit crisis started striking in earnest last summer. The Fed’s initial response was to cut interest rates, hesitantly at first, then much more aggressively. The idea was two-fold:

#1. Drive funding costs lower in order to bail out lenders by fattening their net interest margins (the difference between what they pay to borrow money and what they make on loans) …

AND

#2. Bail out borrowers with adjustable rate mortgages or home equity lines of credit by lowering the cost of paying their loans back.

The Federal Reserve has cut interest rates, and thrown billions and billions at the markets …

But the Fed didn’t just deliver 325 basis points of interest rate cuts. It has also rolled out liquidity program after liquidity program for commercial banks and (later) investment banks.

The Fed’s efforts on that front began in December 2007 with the Term Auction Facility, or TAF. The TAF allows depository institutions to swap securities for Fed loans.

Originally, the TAF auctions were going to offer $20 billion a pop, with 28-day maturities on the loans. But the Fed soon raised the auction sizes to $30 billion … then $50 billion … then $75 billion. The Fed also said TAF auctions would last “at least” six months.

Then this week, things changed again. The Fed said it will now offer 84-day loans on top of 28-day ones. And it released an auction schedule that implies TAF auctions through November at least. In other words, the “temporary” bailout program is now going to last for who knows how long.

And even the TAF wasn’t enough for bailout-hungry lenders!

The Fed was forced to roll out the TSLF — or Term Securities Lending Facility — in March. The TSLF lets primary dealers bring all kinds of less-than-pristine securities to the Fed and swap them for top-notch Treasuries.

Fannie and Freddie debt? Residential mortgage backed securities? Commercial mortgage backed securities? Bundles of car loans, student loans, and credit card balances?

“No problem. We’ll take it all,” said the Fed. The total amount of U.S. debt up for grabs: $200 billion.

Did that do it? Nope. The brokers started facing more funding problems. So the Fed put them on the dole as well, introducing the Primary Dealer Credit Facility, or PDCF. This allowed other dealers, as opposed to just depository institutions, to borrow at the Fed’s discount window. Like the TAF, it was originally slated to be in place for six months.

But surprise, surprise: Our financial institutions apparently aren’t in good enough shape to actually operate without tens of billions of dollars of Fed assistance month in and month out.

So rather than cut them off and let them stand on their own two feet and merits, like American businesses USED to have to do, the Fed just announced that it will extend the PDCF and TSLF programs through January 30, 2009.

Anyone want to lay odds that “deadline” will stick? Didn’t think so.

Treasury, Congress Get into the Game, Too …

At the same time, the Treasury Department and Bush administration started rolling out various programs to help borrowers.

The FHASecure program was designed to make it easier for borrowers who had fallen behind on their ARMs to refinance into FHA-insured mortgages.

Meanwhile, Congress and the Treasury Department have introduced a slew of aid programs!

Then there was the HOPE NOW coalition, a government-industry joint effort to encourage more loan modifications. That’s when lenders extend loan maturities, reduce interest rates for a period of time, or otherwise try to stave off foreclosure by changing the terms of borrower’s mortgages.

Meanwhile, tax laws were modified so that forgiven debt was no longer considered income. Let me explain …

Say you bought a $200,000 house with no money down, and its value fell. You might negotiate a short sale with the lender that would allow you to sell the house for $180,000. You would use the proceeds to pay off that part of the mortgage balance, while the lender forgives the remaining $20,000.

Previously, that $20,000 would have been considered income, and you would have paid taxes on it. That ended when Bush signed the Mortgage Forgiveness Debt Relief Act of 2007 into law in December.

And now the President just signed the massive Housing and Economic Recovery Act of 2008 into law this week. This bill has a little bit of everything:

It authorizes the FHA to insure up to $300 billion in new mortgages. Lenders are required to write down the principal of outstanding loans to 90% of the current value of the underlying properties. Then borrowers can refinance out of their private loans and into new FHA-backed mortgages.
The bill also permanently raises the size of home mortgages that Fannie Mae, Freddie Mac, and the FHA can back or buy — to as much as $625,000 in higher cost areas.
Localities will get $3.9 billion to buy, renovate, and resell foreclosed properties. State housing authorities will be granted permission to sell another $11 billion in tax-free bonds to fund mortgage refinance programs.
And first-time home buyers who purchase between April 9, 2008 and July 1, 2009 will get a $7,500 tax credit (though in reality, the benefit is essentially an interest free loan that you have to pay back over 15 years).

But the most important — and potentially, the costliest — provisions pertain to Fannie Mae and Freddie Mac. The two so-called “Government Sponsored Enterprises” now have access to an unlimited line of credit from the Treasury (Previously, it was $2.25 billion each). The government has also pledged to buy equity from the two GSEs, should they need help raising money.

Officially, these moves don’t bring Fannie Mae’s and Freddie Mac’s $5.2 TRILLION in direct and contingent mortgage liabilities onto Uncle Sam’s balance sheet. But by making the implicit backing of the companies explicit, the government might as well have taken that step.

And of course, the mortgage and housing industries were ALREADY receiving billions of dollars worth of subsidies and tax favoritism.

Since 1997, married couples have been able to exclude as much as $500,000 in capital gains from the sale of their primary residences from the tax man. Stocks and other assets get no such treatment.

Borrowers can also deduct the interest on up to $1 million in first mortgages and up to $100,000 on home equity loans. That means you can borrow $5,000 against your house to cruise the Mediterranean and then catch a tax break for it!

Here’s the real question that needs to be asked …

What’s the Price of All These Bailouts?

My fingers are almost blistering from recounting the various direct and indirect ways the Fed, Congress, and the Bush administration have tried to bail out lenders, borrowers, builders, and everyone else who helped inflate and/or profited handsomely from the housing bubble.

There’s just one problem. Bailing out anyone and everyone isn’t free! The cost of the Fannie Mae and Freddie Mac support program alone could total as much as $100 billion, according to the Congressional Budget Office. All the other provisions in the latest housing bill will likely end up costing billions more.

Meanwhile, the Fed’s actions are increasingly weakening its OWN balance sheet. Total Federal Reserve credit is about $883 billion, up from $850 billion a year ago. The vast majority (about 92%) of the Fed’s money was in rock-solid U.S. Treasuries a year ago. Now only 54% is. That’s a consequence of lending tens of billions of dollars to institutions via the TAF … of assuming $29 billion in lousy paper as part of the Bear Stearns bailout … and more.

And the cost of all the old tax breaks on housing and mortgages (things like the mortgage interest deduction)? Well, that will come to about $148 billion in 2008, according to a Washington Post piece from Robert Samuelson. He writes:

“The real lessons of the housing crisis have gotten lost. It’s routinely portrayed as the financial system run amok; the housing market became a casino. The remedy, we’re told, is to enact rules that prevent a repetition. All this is partly true. But it ignores a larger truth: Our infatuation with homeownership, embedded in dozens of government policies, has turned housing — once a justifiable symbol of the American dream — into something of a national nightmare.

“As a society, we’re overinvesting in real estate. We build too many McMansions. They use too much energy, and their carrying costs, including mortgage payments, absorb too much of Americans’ incomes. We think everyone should become a homeowner, when many families can’t or shouldn’t. The result is to encourage lending to weak borrowers who are likely to default. The avid pursuit of a few more percentage points on the homeownership rate (it rose from 64 percent of households in 1994 to 69 percent in 2005) has condoned enormously damaging policies.”

It’s not like we have all this money lying around to pay for all of these programs, either. New projections show the budget deficit should come in at about $389 billion in 2008. And next year, it’s poised to explode — to a record $482 billion. The previous estimate was for a 2009 deficit of just $409 billion.

What does that mean? We’ll have to sell Treasuries by the truckload to fund all the red ink! You, I, and our kids and grandkids are going to have to pay that bill.

None of this even TOUCHES upon the moral hazard question — whether all these bailouts will just reinforce the idea that lenders and borrowers are free to recklessly speculate, knowing that if they get in trouble as a result, Uncle Sam will bail them out (using our money).

Finally, has anyone stopped to think about whether mobilizing the full faith and credit of the U.S. to prevent or slow the decline of home prices is a laudable goal?

From where I sit, falling home prices aren’t the problem. They are the SOLUTION!

As prices fall, homes will become more affordable for NEW buyers.

They’ll be able to purchase houses with traditional 30-year fixed loans — not all the newfangled crap the industry foisted on people between 2003 and 2006.

They won’t have to take out loans with payments that swallow 40% or 50% of their monthly income.

They’ll be able to enter SUSTAINABLE homeownership, not just get into a house for the sake of getting into a house — and then lose it a year or two later.

Even investors will be enticed back into the market if lenders are allowed to foreclose and fire sale more property. Heck, that’s already happening in some select markets here in Florida, in California, and a few other of the places where prices have fallen the hardest and fastest.

The combination of owner and investor buying, in turn, will reduce inventory levels and get supply back in line with demand … IF we let prices go where they need to go.

It’s certainly food for thought as the bailout brigade keeps riding out from the stables of Washington, D.C.

Until next time,

Mike

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