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Contrarian thinking about the mortgage agencies
The irony of the "subprime" situation, it seems to me, is that we probably all would have been better off if the GSEs had gotten into it in a big way. If the GSEs had been able to create a market in "vanilla" subprime--fixed rates, no prepayment penalties, careful documentation requirements, competitive pricing--and forced their seller/servicers into a "subprime box," the subprime loan market would have been a lot better off. The "pseudo-Maes and Macs" have never really been very good at providing the kind of market discipline within their purview that the real Mae and Mac have. But we wanted "innovation" and "choice" and "flexibility," not domesticated subprime and "alt" financing with low margins, uniform loan terms, and front and side airbags.
Here is much more, very interesting throughout. You can add Matt Yglesias, Atrios, and now Tanta at calculatedrisk.blogspot.com to the list of bloggers calling for nationalization.
Posted by Tyler Cowen on July 14, 2008 at 11:14 AM in Economics | Permalink
Comments
Given the market that subprime represents a vanilla subprime loan probably would have a high enough coupon (500-600+bp above treasuries)that it wouldn't have any takers. The risk is high enough that the rates would have to be at a level that almost everyone could figure out that owning a house wouldn't be a good deal. It was only when the very high actual rate was deferred or hidden (via partial repayment) that sub prime loans were actually obtained).
Posted by: nelsonal at Jul 14, 2008 11:29:57 AM
But Freddie and Fannie did get into subprime in a big way. Not in a straightforward way, perhaps, but they certainly did lower their standards to preserve market share and chase profits. (And indeed, Freddie had very high profits and kept increasing its dividend.) What's being posited is a Freddie and Fannie that would somehow participate in the bubble and yet avoid the mistakes that everyone else made, even while having more generous capital requirements and implicit government backing (among other things) that would allow them to make more risky bets (that turned short term profit).
Posted by: John Thacker at Jul 14, 2008 11:31:17 AM
I'm with Tanta, that the GSEs went as far as their bylaws (and further than prudence) would allow. It seems nonsensical that they should have gone further, with worse loans, and that somehow would have made subprime better.
These are loans that never should have been made. Who made them is of somewhat lesser importance.
Posted by: odograph at Jul 14, 2008 12:25:07 PM
Fannie and Freddie were buying subprime under the guise of calling them "credit blemished" loans instead of subprime.
Posted by: Patinator at Jul 14, 2008 12:25:42 PM
Slippery slope.
Nationalization always fails, and brings countries down with it.
Let's say the climate turns cold ... things could get nasty.
Posted by: loki on the run at Jul 14, 2008 1:16:32 PM
What's really best lost here is that the "subprime" market is a creation of
government interference. Anti "redlining" laws, such as the so-called
"Community Reinvestment Act" directed banks to originate loans among the
so called "under-served" (aka undercapitalized or noncreditworthy)
Clinton moved to "strengthen" this interference in the market in the mid '90's
and here we are...
No sense in assuring adequate collateral, income or sufficient character if
you can unload your loan portfolio, and your only going to be accused of0
"redlining"
Posted by: Superheater at Jul 14, 2008 1:35:48 PM
From the article quoted:
"If the GSEs had been able to create a market in "vanilla" subprime--fixed rates, no prepayment penalties, careful documentation requirements, competitive pricing--and forced their seller/servicers into a "subprime box," the subprime loan market would have been a lot better off."
But low documentation requirements were a defining feature of subprime loans. And the subprime market could not function without prepayment penalties - as subprime borrowers made regular repayments and their credit scores improved, they would be able to refinance at lower rates elsewhere, so without prepayment penalties subprime originators would find their more reliable customers refinancing and leaving while their less reliable ones stayed, which would push the interest rates they charged even higher.
Posted by: Timothy at Jul 14, 2008 2:49:53 PM
Can you explain this point in somewhat simpler terms? I read the whole post but, as a non-expert, admit that I'm not really sure what he's trying to say in this paragraph.
Posted by: blabla at Jul 14, 2008 3:06:31 PM
superheater- EXACTLY!
Posted by: daddysteve at Jul 14, 2008 3:27:40 PM
The contrarian thinking is crazy. The fundamental problem of the bubble was overleverage [not unique to this bubble].
Down payments got smaller and loan transparency became less (because newer instruments were more complicated to understand than the old "pay $800 a month for 30 years"). Both were bad ideas which encouraged individuals to overleverage. [and then there's the bit with packaging this garbage together for resale]
Posted by: ZBicyclist at Jul 14, 2008 5:05:41 PM
ZB,
There is always more to speculative bubbles than just overleveraging,
although that also seems to be a nearly universal accompaniment to
serious bubbles. The rising prices feed expectations that such
increases will continue, which expectations then justify the
overleveraging, as well as drawing it forth as buyers cannot afford to
buy the bubbliciously overpriced assets without overleveraging.
Posted by: Barkley Rosser at Jul 14, 2008 5:53:33 PM
As an alternative to nationalization, would outright abolition be an option?
Probably not (except in some libertarian wet dream), but I wonder... do other countries have any fully governmental agencies remotely similar to the role played by Fannie Mae and Freddie Mac?
Ironically, in Europe where people traditionally routinely accepted and expected a heavyhanded government sector in many domains (infrastructure, utilities, telecom, broadcasting, etc), the mortgage business is handled mostly by the private sector, no? With no quasi or explicit governmental guarantees.
Posted by: at Jul 14, 2008 11:04:23 PM
The S&L crisis and this current mess share one trait. Government allowed people to keep profits while offering support against loss. People will take greater risks if they know they can keep the gains and the government will step in if things go wrong. That isn't free markets, that is stupid.
Posted by: DanC at Jul 14, 2008 11:43:16 PM
But Krugman is wrong. If Fran and Fred had been allowed to invest in the subprime market, a market that was clearly not be served, could they have creamed off the best opportunities and not left enough of a market for the subprime, subprime lenders. BTW I thought the data was that most subprime lenders are still paying creditors.
Posted by: DanC at Jul 14, 2008 11:50:37 PM
It is ironic that when Fannie & Freddie burnout, the guy called upon to shill for them is Krugman, who has gone on record numerous times about how much he loathes suburban sprawl, a phenomenon which would not manifest itself absent a market tampering effected by the quasi-governmental subsidy of housing put in place by the dangerous duo. Delightful!
Posted by: Jason Armstrong at Jul 15, 2008 12:48:11 AM
Land of the Free and the Home of the Subsidy. The brave having gotten out years ago.
Why do we waste so much taxpayer money subsidizing consumption. Yeah, its wonderful if everybody has a house and must blow 6% of its value every time they wanna move, but we make it rewarding to get too much house when we should be focusing on what makes a productive economy.
After all, everyone buying big houses and sitting them does not produce wealth. Its time we got clear on this stupidity and stopped bankrupting the country over it.
Posted by: Al Brown at Jul 15, 2008 6:07:24 AM
Is Krugman misusing "market discipline"? To me, market discipline is the antithesis of moral hazard. It's the risk of loss and bankruptcy from non-commercial behavior. Market discipline is not "provided" so much as it is experienced. Accordingly, IndyMac is now suffering (limited) market discipline where as Freddie and Fannie are being spoiled rotten by their sugar daddy, the American taxpayer (not that I have a better idea just at the moment).
Posted by: John at Jul 15, 2008 6:33:50 AM
That wouldn't have worked -- subprimers were shopping for the lowest teaser rate. Fannie and Freddie could never have competed with what the bubblers were offering: no doc zero down low-teaser-interest ARMs. In the flipper years, too many people didn't care about whether they were fixed or adjustable -- they just wanted their mcmansion at the lowest monthly payment, quals be darned. Even if F&F had responsible programs that were wiser mortgages -- they would only have gotten the financially savvy sub-prime buyers with monthly cash flow to pay a fixed-rate mortgage -- which was a small, small group.
Posted by: DDK at Jul 15, 2008 8:43:50 AM
Krugman view, government regulations kept Fan and Fred from being in even worse shape by blocking movement into subprime market.
Alternative view, subprime market was under served and firms stepped in to fill the void. Absent government regulation, main stream lenders could have cherry picked home borrowers (as opposed to real estate speculators). Speculators would still have gotten loans but at what rate? Would the rate more accurately reflect the risk for the lender (or the final bond holder)? Would more stigma have been attached to these loans and would the secondary market have demanded more of a risk premium? Would the assumption that as a group these loans were safe be subject to additional reviews and greater caution?
Questions, why did housing prices get so inflated in some markets and why was the risk of these loans so wrongly priced? Was it a market failure or did government regulations distort behavior?
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