GSEs: $1 Trillion Dumping Ground for Bad Bank Loans

Post-receivership, the GSEs have become a government sanctioned back door bailout of regular banks. Any mortgage that cannot be refi’d or modified ends up on their books. This includes mortgages on the verge of default and foreclosure.

How much is the worst case scenario for the ongoing bailout of the banking sector, plus Fannie’s and Freddie’s own screw ups?

If everything goes precisely wrong, taxpayers are potentially on the hook for another $1 trillion bailout:

The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

Fannie and Freddie, now 80 percent owned by U.S. taxpayers, already have drawn $145 billion from an unlimited line of government credit granted to ensure that home buyers can get loans while the private housing-finance industry is moribund. That surpasses the amount spent on rescues of American International Group Inc., General Motors Co. or Citigroup Inc., which have begun repaying their debts.

Its not a coincidence that many of these banks are finding the capital to pay back their bailout loans. The Obama administration is continuing one of the more horrific policies of the Bush administration: Using the GSEs as a back door bailout for the rest of the banking sector: These banks are selling their garbage to the GSEs — and according to some anecdotal evidence, are getting pretty close to full boat (100 cents on the dollar) for these bad loans.

Hence, Fannie and Freddie have become a dumping ground for all manner of bad bank loans.

The GSEs have had their own problems over the years — accounting fraud, recklessly chasing market share, lowering loan quality, etc. — but they have now become are now the last stop for every crappy mortgage ever written:

Fannie and Freddie may suffer additional losses as a result of the Treasury’s effort to prevent foreclosures. Under the program, banks with mortgages owned or guaranteed by the companies must rewrite loan terms to make them easier for borrowers to pay.

The Treasury program is budgeted to cost Fannie and Freddie $20 billion. The companies have already modified about 600,000 delinquent loans and refinanced almost 300,000 more, in some cases for an amount greater than the houses are worth.

The government is using Fannie and Freddie “for a public- policy purpose that may well increase the ultimate cost of the taxpayer rescue,” said Petrou of Federal Financial Analytics. “Treasury is rolling the dice.”

A recent Federal Reserve report pegged the total exposure of Fannie and Freddie at 53% percent of the nation’s $10.7 trillion in residential mortgages. That’s about $5.5 trillion dollars.

How do we get to trillion in losses?

About $1.98 trillion of the loans were made in states with the nation’s highest foreclosure rates — California, Florida, Nevada and Arizona — and $1.13 trillion were issued in 2006 and 2007, when real estate values peaked. Mortgages on which borrowers owe more than 90 percent of a property’s value total $402 billion.

That trillion dollar number has a number of challenging assumptions in it. It assumes a large downleg in housing prices, a continuing foreclosure surge, and ongoing unemployment.

My estimates are for about half of that — between $450-500 billion dollars. But with just the right — or wrong — economic policies, bailouts and bad decisions, I wouldn’t rule out a trillion dollar loss. And if we keep allowing banks to dump all of their bad loans onto the GSE’s books, I would raise my odds of a trillion dollars in losses from 25% to 100% . . .


Fannie-Freddie Fix at $160 Billion With $1 Trillion Worst Case
Lorraine Woellert and John Gittelsohn
Bloomberg, June 14 2010

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