A Visit to the US Treasury on Fannie & Freddie

Bill Gross 185K PDF:

Ninety-five percent of existing mortgage creation over the past 12 months were government guaranteed. The private market was nowhere to be found because they charged too much. It was the cost of private origination and securitization, perhaps more than any other factor, that justified government involvement. Prime, but non-conforming, mortgages (jumbos, insufficient down payments) were being purchased by PIMCO in the hundreds of millions of dollars every week, but at yields of 6, 7, and 8%. If that was the risk/ reward tradeoff, compared to FNMA and FHLMC yields at 3.5-4%, how could policymakers pretend that the housing baton could be quickly and cost-effectively passed back to the private market? Few, if any, could afford a new home at those interest rates. If you were a believer in the dominance and superiority of private markets, how could you deny the signal that markets were sending - that the risk was too high given the substantial losses of recent years?

My argument for the necessity of government backing was substantially based on this commonsensical, psychological, indeed sociological observation that the great housing debacle of 2007-2010+ would have a profound influence on homebuyers and mortgage lenders for decades to come. What did we learn from the Great Depression, for instance: Americans, for at least a generation or more, became savers - dominated by the insecurity of 20%+ unemployment rates and importance of a return of their money as opposed to a return on their money. It should be no different this time, even though the Great R. is a tempered version of the Great D. Americans now know that housing prices don't always go up, and that they can in fact go down by 30-50% in a few short years. Because of this experience, private mortgage lenders will demand extraordinary down payments, impeccable credit histories, and significantly higher yields than what markets grew used to over the past several decades.

Interfluidity's notes after a recent Treasury meeting.