The mortgage collapse and the poor

By Phillip Blond
21 Jul 2008

President Roosevelt must be turning in his grave. The mortgage guarantee institution that was created to help solve America's depression-era housing crisis seems to have had a central role in instigating a new economic crisis – and perhaps even a new depression.

On this side of the Atlantic, the travails of Fannie Mae and Freddie Mac are part of that slow-motion American car crash that began in sub-prime mortgage lending and has now extended to these government- sponsored behemoths. On the evidence of the first quarter of 2008, both Freddie and Fannie are massively extended and even, by certain standards, technically insolvent.

At the end of March 2008, they had total credit outstanding of $5,300bn (£2,700bn), of which $1,600bn was debt and $3,700bn represented current credit obligations. But due to their federally sponsored status, the capital requirements for securing such leverage are astonishingly minimal. Against that $5,300bn loan exposure, Freddie and Fannie have only $81bn in capital. Each company has less than 2 per cent capital against its mortgage exposure; good practice would demand three times as much.

This situation – coupled with losses in 2007 of $2.1bn for Fannie and $3.1bn for Freddie, and Freddie's surfeit of liabilities over assets of $5.2bn – prompted William Poole, former chairman of the St Louis Federal Reserve, to claim on 10 July that both entities were insolvent on fair-value accounting rules.

Little wonder that shares in both FMs halved last week and that US Federal Reserve chairman Ben Bernanke has been looking at finding up to $200bn for recapitalising them. Last week Hank Paulson, the US Treasury Secretary, announced moves to secure funding for the two organisations.

These two institutions hold or guarantee over 80 per cent of all US mortgages and as such they are uniquely exposed to the precipitous fall in the value of US housing stock, already down nearly 18 per cent from its July 2006 peak. Moreover, if the asset base of Fannie and Freddie continues its rapid rate of decline, and the US government cannot hold a middle line, then either both businesses will collapse or the debt will be nationalised and move on to the government's books. If either of these extremes occurs, it will make the sub-prime crisis and the current slowdown look like a golden period.

After William Poole's claim of insolvency, the emperor now has no clothes. Both FMs require billions of dollars of public money just to stay solvent, and that is the best-case scenario. If asset values continue their vertiginous decline then all bets are off and a full-scale meltdown is possible.

The real tragedy, however, is the betrayal of Fannie Mae's original mission to house the poor. If only Freddie and Fannie had used their profits to extend mortgage insurance and thus fixed- rate mortgages to the sub-prime classes, who only wanted to share in the wealth, then this recession need never have happened. You don't extend home ownership by concentrating on financing the middle class.

Largely abandoned, the disadvantaged have slipped into the arms of loan sharks, who with zero "teaser" rates and vast increases in subsequent payments, have hoodwinked millions of aspiring Americans.

Sadly, the ultimate legacy of Fannie and Freddy is the new legions of the dispossessed and disinherited.

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A longer version of this article appears in The Independent on Sunday newspaper. Reproduced with grateful acknowledgments.

(c) Phillip Blond is a senior lecturer in theology and philosophy at the University of Cumbria. He writes regular commentary on social, economic and religious affairs for the International Herald Tribune and other online newspapers. http://www.cumbria.ac.uk/AboutUs/News/Experts/Theology.aspx

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