Notes From Underground: Bill Gross calls for “full nationalization”of the mortgage finance system

The housing confab was the big story Tuesday as the Obama administration was trying to figure out how to put the biggest slush fund to work. Last Christmas Eve, the U.S.Treasury–under the spell of eggnog and mistletoe–nationalized Fannie Mae and Freddie Mac by removing the caps on the losses that the two GSEs would be allowed to absorb.We don’t know where “PIMCO’s” Bill Gross was but we had assumed that the removal of loss caps was nationaliztion by stealth. Now as the largest holders of MBSs next to the FED, he is openly calling for outight government control of the mortgage market because Gross doesn’t believe there is room for the private sector. Yes, he is correct if the mortgage market reverts to NINJA loans and other zero-down types of nonsense. However, if the originate-to-distribute model were to be restructured so that only deserving loans were made, private lenders would be lining up to get into that business. We caution our readers to understand that today’s conference on GSEs was meant to give some type of cover to an already conceived plan of how Fannie and Freddie can absorb more losses and for the Obama team to gain some political advantage.

Our conjecture is that the two behemoth GSEs are going to force a rewrite of existing mortgages so that as many borrowers as possible will be locked in at much lower rates than their credit ratings would allow. A 30-year fixed rate that was close to the Treasury’s borrowing rate would be similar to a giant tax cut for all of those eligible. This, we believe, will be the October surprise and the result will be that the Democrats are working for Main Street. The result will be positive for the housing market because it will stem foreclosures in the near term and the government will absorb the hit as will some bond holders will be forced to accept a lower rate of interest (see GM and Chrysler for bond holders rights). The Obama administration has not gotten the bump in employment and they know that they will lose control of Congress if they do not appear to be doing something dynamic for Main Street. The biggest problem is who is going to absorb the haircut on the lowered rates besides Treasury. Hmm … it may be the Chinese who also hold a great deal of GSE paper. Wow, lifting the spirits of Main Street while causing mild pain to the Chinese. The only question is how it will affect the U.S. image in global capital markets? Otherwise, we are sure it will play in Peoria.

A MINOR NOTE: It seems that in the usual legislative fashion there was more to FinReg than meets the eye. U.S manufacturers are up in arms regarding the inclusion of provision termed “conflict minerals.” The provision that was slipped into the 2300-page bill requires companies to declare if its products contain minerals from the Democratic Republic of Congo. Many of the raw materials used to make the guts of modern technology emanate from the Congo, where much blood is being spilt over who will control the profits on these exotic elements. This goes back to the “blood diamond ” issue that plagued Mozambique and Angola, but the ramifications of this proviso are far greater. We are not making a political statement about the Congo but just pointing out the irrationality of our own legislative process and the problems caused for U.S.-based business. We wonder if the Politburo in Beijing has tied the hands of Chinese high-tech producers. And you wonder why 2+2=5.

Tags: , , , , , , , ,

15 Responses to “Notes From Underground: Bill Gross calls for “full nationalization”of the mortgage finance system”

  1. Arthur Global Practice Says:

    Perfect Yra! 10 points!

  2. kay Says:

    Should this come to pass- I would imagine a behind the scenes deal has either already been determined or is in the works- with China to buffer any losses.
    It difficult to fathom that our country would “cheat at the card game where the other guy holds most of our chips.”

    Ira: in regards to the NINJA loans- do you have any comments on the FHA now providing a guarantee on purchase loans for expensive luxury condos in NYC? Result is low downpayment with taxpayer backing via guarantee and voila- you are in a new million $ home.

  3. kay Says:

    My apologies: mistype

    YRA of course, not Ira.

  4. jeff Says:

    Interesting to think about this with the context of a Fed meeting in 5 weeks where I fully expect another quantitative ease.

  5. Danny Says:


    I could easily be wrong, but it doesn’t seem that mortgage rates being too high is what is plauguing the housing market. It seems much more likely that the negative equity gap created by underwater homeowners is a far bigger problem.

    If I understand your argument correctly, you are suggesting that the objective of this policy is to further reduce existing mortgage rates for middle America in an effort to relieve their monthly cash flow conditions? I have to wonder if the implications of this policy are actually far more negative in the long run and quite frankly not effective in the short run…

    Theoretical example….

    The scenario: A homeowner is underwater on a mortgage. Their house payment, in large part because of high interest rates, puts the homeowner into a tenuous situation at best each month.

    The action: policy response that leads to a reduction of interest rates on the existing note of the homeowner.

    Homeowners response: since the homeowner was in a tenuous situation on a monthly basis before, and now their interest rate is subtantially lower thereby reducing their required monthly house payment…they will not pay as much per month on their house. Cash flow relief has occurred, great!

    Implication 1: bond holders are forced to receive lower interest payments than they were previously receiving.

    Implication 2: the homeowner’s negative equity gap remains substantial and the the rate of equity restoration does not increase in a meaningful way (since the monthly house payment was reduced). Without restoring the negative equity gap, the homeowner will remain in this particular house until such time as the capital loss on the house is tolerable for the homeowner or they have flat/positive equity in the home (which will take a long time depending on your view of the housing market).

    My take: focusing on further reductions of mortgage rates misses the point. The plaugue of the housing market isn’t elevated mortgage rates. I think recent discussions by the Federal Reserve serves as evidence of my point as they have been rather unimpressed with the effectiveness of quantitative easing to spur housing market activity.

    The plaugue of the housing market is the negative equity gap. Without addressing this problem head on…policy makers are relying on the system to naturally work off the negative equity gap…which with a very weak employment situation, increasingly slow growth, increasing tax rates and healthcare costs, etc. it will take a long time to work itself out naturally.

    Just how severe would the implications be by forcing the banks to eat the negative equity gap via the bailout money instead of allowing them to play the multi billion dollar arbitrage caused by 0 interest rate policy while they wait for homeowners to work off the negative equity gap before demand for lending increases? Sure banks would be forced to take some capital losses from write offs…but wasn’t that what the bailout money was for in the first place? I have a tough time believing they will further reduce lending, when there is limited demand for lending in the first place – in large part, in my view, because of this negative equity gap.

    Thanks for your time,


  6. yra Says:

    danny alot here and inits full sense I don’t read anything I disagree with–which is why the initial october surprise was to be a write down and new mortgage at the lower rate—but because the mortgages are underwater the banks will not renegotiate—but just think that even if the underwater mortgages get refied at a lower rate–some of these are at rates that came off exploding arms so the payments are higher then you think resulting in a much greater flow of money to main street

  7. yra Says:

    also Danny you can not get any debt relief thru refi because of the negative equity gap

  8. jojo Says:

    It started when the Chinese made calls to Bush/Paulson explaining to them that the Gov needed to get in there and back Fannie and Freddie during the meltdown or they would sell their holdings on the open market.
    Then the big swapout began. THe Chinese are mostly out already.
    No haircut…
    The u.s. taxpayer on the other hand….?

  9. jill Says:

    I do not agree that mortgages will be rewritten. It was easy for the U.S. to “bully” the bondholders of GM and Chrysler since most of the holders were union pension funds and “to big to fail” financial firms who all play in the same sandbox. No the U.S will not mess with China nor other foreign governments since GSE debt is essentially sovereign debt and the U.S will choose not to go down that road first.

    The banks will become more and more decapitalized as they suffer losses in their stock and currency trades. Their special FASB 157 entitlement will fail to keep them in business and credit and lending will simply dry up. The banks will then turn to foreclosing and leasing properties. A new banking business model will then emerge, that being property management on behalf of government.

  10. yra Says:

    Jill –interesting but what will the banks give to get that trade off—see Gretchen Morgenson’s Sunday NYT piece—nothing is free and the politics of this Admin are very interesting

  11. Bill Gross calls for “full nationalization”of the mortgage finance system Says:

    […] Notes From Underground: Bill Gross calls for “full nationalization”of the mortgage finance syste… […]

  12. NW Exec Says:

    Interesting piece, may write something up and link it. Pimco has some interesting points of view, hope they are right. Here is more from an interview with Pimco’s CEO:

  13. kay Says:

    Jill has interesting points. I agree that our gov will not leave China high and dry but this may be accomplished via another quietly arranged trade-off.

    If the banks turn to foreclosing and leasing as their means of buffering losses from the stock/currency trading desks, who represents the leasee market? Surely not domestic?

  14. Business 2 Business Says:

    Thanks a lot for this topic.

  15. Trent R Says:

    Hi great reading your bllog

Leave a Reply

%d bloggers like this: