Over the holidays the US Treasury issued an update on the status of government support for housing programs. Here is a quote from the release:

"Today, the U.S. Department of the Treasury provided an update on initiatives established under the Housing and Economic Recovery Act (HERA) of 2008, which supports housing market stabilization and provides relief to struggling homeowners. As part of a commitment to wind down programs that were established during the crisis and are no longer critical to financial stability, Treasury will terminate several HERA programs at the end of the year. Treasury will also amend the terms of its agreements with Fannie Mae and Freddie Mac to support their ongoing stability. The steps outlined today are necessary for preserving the continued strength and stability of the mortgage market. "

First, a quick overview of what the US Treasury announced:

  1. The US Treasury's $200 billion GSE MBS purchase program (not the Federal Reserve $1.25 trillion program) and the unused short term credit facility established for both enterprises and the Federal Home Loan Banks would terminate as scheduled on December 31, 2009. 
  2. To provide greater flexibility to its funding commitments  to Fannie and Freddie, Treasury made  "technical change" to definitions of assets and liabilities in the Preferred Stock Purchase Agreements (PSPAs) in light of accounting changes driven by Financial Accounting Standards (FAS) 166/167.
  3. It would give the two housing finance enterprises greater flexibility in meeting their portfolio reduction requirements;
  4. Delaying for one-year to December 31, 2010, setting the periodic commitment fee the GSEs will owe on unused financing;

My take on Treasury’s action is that in some ways they are assuming the role of financier of the GSEs from the Federal Reserve with the intent of ensuring the GSEs play an active role in the secondary mortgage market as a net buyer of mortgages. Few would argue that the GSEs have played and should continue to play important roles in the implementation and administration of Making Home Affordable initiatives . The more contentious role for the GSEs is as purchaser or guarantor of mortgage assets at this point in time.

Prior to the announcement, it was reasonable to envision some sort of orderly liquidation or run off of their massive portfolios, or even the widely contemplated "bad bank" that would isolate the nearly $500 billion of non-performing loans that they own or guarantee in an effort to perimeter fence their respective credit problems. Now I can only envision the GSE's portfolios growing for the foreseeable future, and with the serious delinquency rate growing exponentially, the Treasury will have to continue to invest in the enterprises to keep their net worth above zero. "Don't ask - Don't sell" is not the way out of the country's housing crisis.

If the Federal Government is committed to essentially backstopping and/or financing the nation’s housing finance system for the near term then we have to find a way to do it most cost effectively.  Is investing in the GSEs as proposed the most economically prudent mechanism for supporting the housing finance system a large?  Probably not, but what’s the alternative?

Consider this question: How much does it cost the Federal government to increase the funding authority of the Federal Housing Administration? In other words, if the administration were to double or triple the annual funding authority of FHA from its' current limit of $400 billion in 2010 to $800 million or perhaps $1.2 trillion you could potentially create a market to soak up GSE portfolio runoff and new originations.

In other words, instead of uncapping the GSE's portfolio limits - which requires offsetting capital infusions from Treasury - why not expand the cap on the amount of insurance the FHA can underwrite instead? Theoretically, it does not cost the Government any money to increase FHA's commitment (lending) authority. And given that GNMA securities are explicitly backed by the full faith and credit of the United States, a robust and natural mechanism already exists to buy the securities without further federal involvement or subsidies.

Although FHA’s actuarial accounting places a heavy emphasis on the net present value of all books of business over a 30-year period (all 5.1 million homes in their current portfolio) who better to hold those mortgages over the long-term than the FHA and Ginnie Mae?  You need the full faith and credit of the US Government to wait out the market’s current house price declines.  Like all crises, this one too shall also pass and house prices will at some point begin to increase.

Agency debt, on the other hand, requires the federal government to create an artificial market where they themselves are the only buyers because the securities lack an explicit federal guarantee like GNMA required by private investors. Whether the guarantees are implicit, as is the case with the GSEs, or explicit, as is the case with FHA/GNMA - the ultimate “bag holders” are the taxpayers. The bandwidth, capacity, and operating capital it would take to fight the current crises across four somewhat disparate mortgage finance agencies - Fannie Mae, Freddie Mac, Ginnie Mae, and FHA - needs to be centralized to one or two organizations.

FHA and GNMA should be looked at as the primary liquidity sources for mortgage financing until such time as the GSEs can fund their own portfolios, or establish a competitive value proposition to investors for their mortgage backed securities. This approach would be a long-term hedge against the GSEs being unable to reemerge as independent viable businesses.

The US Treasury could allocate a fraction of what is being "committed" to the solvency of the GSEs to initiatives directly designed to assist distressed markets and homeowners. Sustainable foreclosure prevention programs like the “new and improved” FHA Hope for Homeowners program, which forgives principal but allows the government to share in future appreciation of the home’s value, could be widespread with Treasury funding for principal reductions. Some of the unspent Treasury dollars could be used to allow the GSEs to sell some of their riskiest or best assets (depending on risk management philosophy) and take the losses.

I feel the current approach of using Treasury funding to increase GSE portfolios, allowing them to take on more risk, and delay dealing with the problem is far more dangerous and costly in the long run.