Monday, December 22, 2008

The Hubbard-Mayer Proposal to Nationalize Housing Finance – Can the Government Make Money on Socialism?

James Kwak has a nice discussion of a proposal that Brad DeLong endorses thusly:

We are drifting toward nationalizing housing finance. And as long as the government can borrow at the Treasury rate it can buy up and refinance the country's stock of mortgages without paying a dime in the long run. The largest risk-arb operation in history--and since the government can mobilize the entire risk-bearing capacity of America, a very low-risk one

According to the Federal Reserve, long-term mortgage rates are near 5.2 percent so the Hubbard-Meyer proposal is to finance them at rates well below current market rates with long-term Treasury rates are near 2.5 percent. How much of this difference represents the expected return premium that Brad hints at versus the expected losses from default, which the government will inherent? I’m not sure but Kwak offers us the following:

One question is whether the loans will be sustainable. Hubbard and Mayer say that 1.9% is more than enough because the ordinary spread is 1.6%. But these are not ordinary times, and even if the plan does help turn around the economy, we are probably looking at 1-2 more years of rising unemployment and resulting defaults. Furthermore, conforming mortgages rates are already down to 5.2% (thanks in part to the Fed talking rates down), so Fannie and Freddie could face the problem of getting stuck with riskier mortgages while the private sector keeps the better ones.

While this discussion does not answer the question, it does suggest that default risk today is higher that the historical spreads that Hubbard and Mayer are relying upon.


Anonymous said...

Isn't this going to screw all the investors in prime mortgage bonds-because of all the resulting prepayments from the refinancing?

So, it is a transfer from prime lenders to?

TheTrucker said...

So what's your point? If they get paid off then why are they whining? Or am I missing something here? Special purpose entities set up to do CDO's would seem to pay off as planned. Why does that screw the current bondholders?

Anonymous said...

The big risk in prime mortgage bonds is prepayment risk---getting a big chunk of money back when rates are low. This of it this way-if the original loans had a 6% rate, and money comes because when you can only invest at 2%, you have lost 4% coupon payments.

There is no default risk in the bonds, because those bonds are insured by Fannie and Freddie. And they are prime loans--make to people with high credit ratings and high(er) downpayments.

So, if we artificially lower rates to encourage people with high rating to refinance, it is hurting the holders of the original prime mortgage bonds. And as far as I can see, the Chinese government is a big holder of those bonds.

Anonymous said...

sorry for the typos :(

Ken Houghton said...

"So, if we artificially lower rates to encourage people with high rating to refinance, it is hurting the holders of the original prime mortgage bonds. And as far as I can see, the Chinese government is a big holder of those bonds."

That's the first reasonable argument in support of the proposal I've seen. (Oh, wait...)

More seriously, if you're looking at the Good Done by lowering mortgage rates to 4.5%, you have two choices: (1) lower only for new purchases, which is virtually useful if no one can get a loan or (2) offer the rate to current mortgage holders as well, at which point I'm refinancing again and someone who is slightly closer to the margin is still going over the edge.

In the case of the MBS holder, the notes are still getting called early, but it's a cleaner process that doesn't cost so much.

What is left as an exercise is what happens if qualifications are imposed on current mortgage holders for receiving the 4.5% rate. As a finger exercise:

The about-to-be-foreclosed are still foreclosed, and the bondholders have to wait for payment.

The marginal (or Reluctant) homeowner may not qualify, which will force them to try to sell into a market with Mythical Rates that are Not Really Available.

I'd rather try to sell to someone who isn't waiting for the 4.5% miracle, but rather has or can get current financing. Anything else is, at best, a non-market or off-market transaction.

Anonymous said...

Anonymous's concern about bond yield losses seems like swallowing blue whales and straining at gnats given that two weeks ago, people were paying a premium for zero-percent Treasury bonds (effectively a negative yield).

With respect to defaults on home mortgages for owner-occupied residences, is there any information about how much of the defaults relate to higher interest rates versus total inability to pay ? If some of the unpaid interest can be forgiven (or deferred and paid upon sale of the property) and the homeowner gets back into compliance then some foreclosures could be avoided. I have lived across the street from an unoccupied house for over six years, which is not good for the neighborhood -- having lots of empty houses seems like a bad idea.

Anonymous said...

Great plan... let those folks who are in over their head make good by lowering they payment there by reducing the toxic assets and let the people who are stuck with paying for relief get some disposable income to spend some to get the economy going.

signed .. Working Stiff