Spring Break: How Fannie & Freddie Will Bail Us Out

I recently detailed the trouble that's coming for American home owners with the end of the recession (except not for us), the recovery of the big banks (but not commercial lending), the rise of the stock markets (but not jobs), and the likely further declines for housing as what little stimulus was being applied there (less than five percent of the total) finally expires. Now I'll turn to what can or will be done to fix this mess.

But first let me share what I was told recently by the managing partner of a New York hedge fund after reading my earlier post. "Unfortunately, I agree with you," he said. "However, in this Alice in Wonderland world, sometimes what is bad for Main Street is good for Wall Street."

There are three interested parties here -- big business and Wall Street, the federal government, and the American people. We got where we are because big business and Wall Street offered us cheap loans and we took them so we could buy that RV and put our kids through college. When the housing bubble burst, government protected big business and Wall Street, seeing them as essential to any eventual recovery. Government didn't do much to help the American people because Washington was too busy helping business and Wall Street, and we weren't going anywhere, were we?
But now it is 2010, an election year, and our chance as citizens to be heard at the polls. Over the coming months our political leaders will sound less and less like Wall Street and more and more like Main Street, which might be gratifying but doesn't mean anything will actually happen. It won't at first because of the current political deadlock between conservatives and liberals over how much pain we have to feel before this thing is over, de-leveraging is complete, and we can start buying and selling houses again. For the moment, then, we'll have a lot of shouting and finger-pointing and even more praying for that miracle which won't come.

Eventually, though, as primary elections loom and the Democrats start feeling a little shaky in their electoral boots, they'll have to do something to please the voters, or at least distract them. This will inevitably be some form of further economic stimulus. But the problem is that there is no political will for such stimulus: Congress may need it to stay in power but they won't vote for it because doing so might boot them out of power.

We have a dilemma.

Fortunately, the Obama Administration created last month a Get-Out-of-Jail-Free Card in the form of increased debt limits that it will cover at Fannie Mae and Freddie Mac, from $400 billion to infinity. And our economic salvation this Spring will come, as Buzz Lightyear says, by going to infinity and beyond!

Something has to happen to break open the housing market. There is no miracle recovery on the way, no chance for a formal stimulus and no will to increase the deficit even further. But Fannie and Freddie, which have been tightening their lending requirements for over a year (since BEFORE the housing crisis, in fact -- something they never even tried to mitigate as everything was going to Hell) can always go the other direction and loosen requirements, too.

Think about it. There is no loss limitation on Fannie or Freddie, which are effectively now tools of the U. S. Treasury, though cleverly maintained off the books and out of any Federal deficit numbers. The new, highly-paid CEOs of both organizations are getting none of their compensation in the form of stock, which presupposes that the stock will be going nowhere but down. These guys have nothing to lose.

Sometime this Spring, on a quiet word from the White House, Fannie and Freddie will drop their lending requirements back to where they once were or even lower. They'll start buying mortgages from anyone on any property even if doing so makes no economic sense. They'll throw $1 trillion or more of off-the-budget money at the problem, buying crazy mortgages. And the bankers, who haven't learned all that much from this experience but still love to make crazy deals if they are profitable for a moment and can be sold on to some sucker, will start lending in earnest. For a while.

It won't be a permanent solution of course. That would require an act of Congress. But the purpose of this temporary bubble reflation will be to get beyond the 2010 election with minimal Democratic carnage while saddling the Republican Party with responsibility for a continued crisis in jumbo mortgages (over $729,717) which are too big to be bought by even a temporarily insane Fannie or Freddie.

Sometimes what's good for Main Street is bad for Rodeo Drive.
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