The federal government’s housing rescue plan signed into law this past week contains a lot of what we might expect. Faced with a seemingly endless mortgage problem that threatens public confidence in financial institutions, they decided to throw some big-time money and the “full faith and credit” of the U.S. government into the market.
Laws are made by Congress, of course, so we should expect some compromises with reality. And in this case we get it in the form of $3.9 billion in neighborhood grants to be used to purchase and fix up abandoned homes. This provision is a triumph of hope over experience, but if we close our eyes real tight and wish real hard, maybe the idea will actually work.
The big money in this plan is in authorizing the Federal Housing Administration to refinance $300 billion worth of failing mortgages so that homeowners can retain their homes. Whether this is enough money to turn the market psychology around is hard to say, but it can’t hurt.
The new law also boosts the size of mortgages that Fannie Mae, Freddie Mac and the FHA can purchase from lenders in areas where the cost of housing is high. The new maximum is $625,000.
From an economic policy standpoint, there are aspects of the new law that are especially interesting. It represents our first, hesitant steps toward a more realistic, but far more complex, approach to economic policy and public accountability. By introducing statistical probabilities, it could be as far-reaching as the introduction of quantum mechanics into the world of Newtonian physics.
Within the law there are emergency provisions that allow a larger line of credit to Fannie Mae and Freddie Mac, if needed. They each have a credit line now — $2.25 billion each — and the new, emergency borrowing allowance, which is unspecified as to amount, is meant to quell any doubts about these agencies’ ability to meet their obligations. Emergency provisions also allow the Treasury Department to buy into either Fannie and Freddie, or both.
This is an important matter, and not just for our domestic housing and mortgage markets. Foreign governments hold nearly a trillion dollars worth of Fannie Mae bonds — China alone holds about half of that — and both its liquidity and capital positions are significant factors in the U.S. government’s position in world financial markets.
Because this represents a financial commitment for the federal government, though, the Congressional Budget Office was asked to evaluate its cost to the taxpayers. It is a future, contingency commitment, though, so this is a matter of likely, not actual cost. It is very different from a traditional accounting problem. Probabilities have to be invoked.
The budget office eventually concluded that there was a better than 50-50 chance that the cost to the taxpayers would be zero — that is, if the emergency authorizations were never used. They also estimated that there was a 1-in-20 chance that Fannie and Freddie would need $100 billion, which would never be seen again, but the most likely situation would cost the taxpayers $25 billion.
Contingent liabilities are a particularly salient issue in the Fannie and Freddie situation, since these financial institutions were set up by the federal government but, after receiving Congressional permission, sold stock and now operate independently. In financial markets, however, especially overseas, they still appeared to have government backing — and now, of course, they do, thanks to worries about a deteriorating market.
Congress views its role of Fannie and Freddie’s guardian as temporary even though the market may not see it the same way. The new law, though, does create the job of regulator, or nanny, for the two of them, to be vetted by the Federal Reserve and with the power to establish capital requirements for each.
The whole idea of capital requirements may require more math and probability estimates than it used to. Capital requirements in “traditional” home mortgage lending, for example, are usually quite modest. For subprime lenders, though, considerably more capital would be needed to be considered adequate. Figuring out exactly how much, of course, would require knowledge of the business, of the markets, and of statistical probabilities — at a minimum. Welcome to 21st century risk management. It’s no piece of cake.
Being a nanny to those two won’t be easy, but it will at least bring some additional visibility to the federal government’s risk management process, or lack thereof. We have been woefully behind in determining the risks and costs — contingent and actual — involved in economic policy.
The housing rescue law is neither beautiful nor perfect, and it has its critics. But it, or something like it, was needed, and needed right now. With any luck, it will help.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.
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