paper about MBS

This policy creates fictional housing wealth that

Info iconThis preview shows pages 83–85. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: This policy creates fictional housing wealth that allows households to consume beyond their true borrowing capacity. Indeed, U.S. mortgage equity withdrawals were the engine of world economic growth between 2000 and 2007, but they could not be sustained once the housing bubble burst. While this game of kicking the GSE can down the road has been ongoing for decades, the dire fiscal situation of the United States shines a new light on it. It amounts to a massive government gamble on the housing market. Despite their insolvency, Fannie’s and Freddie’s balance sheets continue to expand, and the government simply continues to plug the hole as and when losses arise. These losses – almost entirely due to the delayed recognition of the disastrous mortgage investments pre-2008 – have currently accumulated to $148.2 billion. The initial “keepwells” of $100 billion each for Fannie and Freddie have been raised to an unlimited draw on the Treasury through 2012. Instead of setting aside additional capital upfront for future losses, the cap on the size of the GSEs has been abolished. This is unlike Citigroup, another institution that would have hit insolvency without the Federal Reserve backstop and 82 government recapitalization, but which is trying to shrink over time to about half of its pre-crisis size. Continuing expansion of the Fannie and Freddie balance sheets and the current 70%+ share in guaranteeing new mortgages (over 90% if we include FHA) – even as their risks remain unrecognized on the federal balance sheet – is the government’s “doubling up” strategy. Doubling up is a strategy that financial traders follow when they have exhausted all of their capital in bets that have gone bad. Sound strategies might involve cutting the losses and exiting the trade, or raising more capital to withstand further losses. But these strategies would be privately costly for the traders. Hence, they either stay the course hoping that things don’t get worse or they even try to gamble more in the hope that they get resurrected before the losses materialize. In the case of the GSEs, such gambling takes the form of an under-capitalized expansion of their balance sheets. This is at least in part enabled by access to the Fed’s balance sheet since this keeps risks temporarily off the government’s balance sheet-- that is, for some future administration’s balance sheet. It is possible that the gamble will pay off and the housing price rebound will eventually win the race against further losses on GSE mortgages, limiting future holes to be plugged. But the outcome of that race looks increasingly uncertain. In summary, it is unclear why the Fed is the right choice as a long-term storage facility for GSE securities. This is really the task of an asset-management company. Even the Fed’s holdings of securities from Bear Stearns and AIG are being “run” by an asset management firm for a fee. All of this can be transparently done through an RTC-style “bad bank” that is owned and funded by the Treasury. and funded by the Treasury....
View Full Document

{[ snackBarMessage ]}

Page83 / 151

This policy creates fictional housing wealth that allows...

This preview shows document pages 83 - 85. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online