The fate of the zombies? Who else but Fannie Mae & Freddie Mac. What will be the future of housing finance?

The fate of Fannie and Freddie has been put on the back burner while Congress is busy with the passage of the financial overhaul bill since last year. However, the Obama administration has convened a housing summit this week to discuss precisely the fate of both behemoths. Both agencies have cost taxpayers $148 billion in bailouts so far, with no end in sight. They are also backstopped (unlimited) by the government until 2012.

What is certain about these agencies is that there are no easy solutions to deal with them, which certainly will cause heated debates between the government, bankers, Congress, and last but not least U.S. taxpayers. The first salvo was fired by Geithner, who said "we will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support." Furthermore, he said "we will not support a return to the system where private gains are subsidized by taxpayer losses." To me, that is the crux of the whole mess concerning these 2 agencies.

Available solutions range from full nationalization at one extreme to privatization with no government support at the other, with alternatives in between. Government guarantees may need to be provided to cover the risk of losses and structured to minimize taxpayer losses. The government would have to decide how to structure such guarantees, determine which loans would qualify for insurance, what the underwriting standards should be and how private mortgage insurance might be used. Full privatization at this point is not feasible because the agencies and FHA guarantee more than 90 percent of all mortgage loans in the country. Without their guarantee, mortgage rates will increase and cause housing demand to sap which in turn depresses home values further.

Bill Gross from Pimco argued for "full nationalization" of the mortgage finance system. He suggested that private financing is unrealistic and impractical. This is at odds with government officials who have urged for a smaller footprint in the housing market. Furthermore, Geithner reiterated the need to begin the process of weaning the markets away from government programs and make room for the private sector to get back into the business of providing mortgages. The need to keep mortgage rates reasonably priced is also important for mortgage borrowers.

The government has targeted to overhaul housing finance by January 2011. However, the voices that called for full government support will only hamper the progress to wean both Fannie and Freddie from further taxpayer bailouts. Solutions will be forthcoming from both sides, but I think a solution with structured government guarantee and private capital will probably be the way to go. A healthy market with competition would be the best way to encourage more private capital to provide mortgage solutions. At stake is the more than $10 trillion US housing market.

The aversion of Financial Armageddon and the arrival of spring

Over the last few weeks, things have gone from bad to worse in the US economy, and around the world. In the US, the scant details of the bank bailout has badly shaken investors' confidence, especially after Geithner's plan rolled out, but without much details on how the plan will work. The only new thing is the public-private ownership, where private investors fork out money to invest in bad assets, with government's backstop. US stocks got hammered, with the Dow hitting 6440, a new low. Again, financial+insurance stocks bore the worst, with the guillotine finally fell on the pristine AAA rating of GE and Berkshire Harthaway. Rating companies had cut the ratings of both companies, but the implication is enormous because they were known for their stability. GE Finance arm is the culprit here, having made lots of loan investments to homeowners and Eastern Europe.

Around the world, Eastern Europe is in a freefall, with their western brethren reluctant/unable to offer much aid/loan due to their survival is also at stake. Debt for some Latin American nations would soon default. Iceland is still in iceberg condition. World trade is stagnant, except for a glimmer of hope in China where their stimulus money is starting to kick-in. A lot of Asian countries are effectively devaluing their currencies in order to compete. To me, this is not effective at all to help their exports, since world trade is in the doldrums. Japan exports have been heavily hit, especially the automotive industry. For the first time, Toyota is asking its government for a bailout.....

However, with the arrival of spring, things are starting to turn up better in March. The mere mention of regulatory overhaul of the financial system in US by Bernanke sparked a rocket-up movement in the stock market. Congress is also mulling the "uptick rule" and "mark-to-market" accounting practices. These steps would generally help to restore investor confidence, but they are not the solutions to this financial crisis. Moreover, any idea to set the bad assets to any value, other than its real value, would distort the pricing as well as breeds mistrust. No one would buy the assets if they are marked "high". Also, financial institutions balance sheets would suddenly look good and stocks would go up. This is done so that the big banks could escape from being "Nationalized".

My predictions -> Federal Reserve and the government are trying to introduce steps to halt the economy from going to the abyss, however, these are just remedies for the symptoms, and not the cure for the root cause. Time and time again we know these strategies would not work. They are trying their might to stop the inevitable, which is Bank Nationalization. Nationalization is going to be tricky, because the government has to choose which investors to protect, i.e senior bondholders, preferreds, trust preferreds. We know the common shareholders would be Toasted in this scenario! If UncleSam does not protect the bondholders and preferreds, PIMCO and insurance companies would be TOASTED as well. At the same time, the government has to dole out money to fill the gaping hole for Fannie, Freddie, AIG and GM. Ladies and gentlemen, this is really an Economic Pearl Harbor! Money has to be spent to keep the system going, and it has to come from US taxpayers. They are truly Toast.

US Stimulus and the new bank bailout 'most' likely would NOT work

As we are getting nearer to the Stimulus passage as well as a new bank bailout, I am fully convinced about 2 things:

1) The Stimulus plan is smaller than expected, and it is a hodge-podge of ideas, with not much specifics. Worse of all, it doesn't even have a coherent theme in it. The new administration just wanted to have bipartisan support, and succumbed to demands from all sides. Furthermore Nobel laureate Krugman has ranted about it in his blog yesterday.
My prediction is that even though the bill is signed this month, a lot of work projects would begin without a system to monitor its progress. After a few months, if unemployment still hovers or exceeds present level, and the economy has not shown any signs of life, then the world markets will slide to the abyss once again. We could have Stimulus II & III then, but it would be too late.

2) The new bank bailout plan, I believe, is still work in progress, without much clarity and certainty. We should expect the status quo to remain; American taxpayers getting hosed, and trash assets still marked at preposterous level. There is talk that "mark-to-market" would be suspended. I believe this is an act of desperation from the govt, so that they could delay the inevitable. What is it? That the bank stocks would go to zilch(0) eventually, since the financial losses have trumped the market capitalization of all banks combined. The tricky part, how much the govt needs to pay for the bad assets when the 'bad' bank is created? We will find out soon. Looks like nationalization is the only viable alternative left, although vested interests are totally against it.