William Poole’s CNN piece titled, “Are We Heading Toward Another Subprime Mortgage Crisis?”, has an interesting gist to it. William Poole is a retired president and CEO of the Federal Reserve Bank of St. Louis. He left the bank, which is a part of the Federal Reserve system, in March of 2008. He knows a bit about the crisis. He argues that the mortgage crisis in 2008 started with Fannie Mae and Freddie Mac. Since they were GSE’s (Government Sponsored Enterprises), ultimately, the bucks stops at the G. Today, Mr. Poole points out that mortgage credit score requirements have come down quite a bit. Fannie and Freddie have redefined “subprime” to be mortgages taken out by borrowers with credit scores less than 620. In 2008, the minimum score was 660. The consequence is that many mortgages in Fannie and Freddie’s portfolio are NOT subprime today, but were subprime in 2008. How this makes any sense I don’t know, but let’s try to figure it out.
The reason Fannie and Freddie requirements are down so much is because banks have made it very difficult to get a mortgage, post-crisis. Banks were so burned in the crisis, they refused to make loans, even to buyers with high credit scores. They refused applicants on other ground, such as debt-to-income ratios, or on property type. For example, JP Morgan Chase would not do multi-unit, new construction, condo loans in Chicago, the on the basis they were hard to value without historical sales. The effect of this tightening of credit made the housing market inaccessible to most when it was at its cheapest. Almost all buyers were therefore cash buyers. They were investors, real estate trusts, and yes, hedge funds; they swept and bought aggressively, as prices were further depressed by low demand caused by lack of mortgage availability. It’s still happening today, even as home prices surge. Mortgages are still hard to come by for the individual buyer. There is evidence the surge in home prices is tapering off, as inventories, especially of high-rise rental properties, explode higher. In a recent CNBC article, an excerpt states,
“Sales of existing homes are down for the third month in a row due to a shortage of properties, which results in higher prices and pushes some potential buyers out of the market.”
This tells me that the rise in home prices has priced many buyers out of the market. Individuals were first priced out at first, by cash buyer investors, and lack of credit. Now, they are priced out by a supply crunch, driving prices even higher. This rise in prices will most certainly eventually trigger more supply; the problem is that the supply coming being built is not single family homes. It’s primarily high-rise rental properties in urban centers. Affordable for-sale housing continues to be a segment builders refuse to enter; its an ongoing theme since the crisis. The psychology of the crisis, the pain that builders took when they couldn’t sell their inventory, still lingers. There is a disheartening conclusion that can be made from this: affordable housing, to own, may be a thing of the past. Millennials, now reaching their mid to late 30’s, are abandoning home ownership. This is why, as we mentioned above, investors continue to buy single family homes to put up for rent, even as prices for those homes skyrocket due to the supply-crunch. Investors realize millennials still want to get married and start families. They don’t want to raise a family in a high rise rental. Investors are betting that millennials will no longer look to buy; they will from here on out, “rent the American dream”, and it will be big business. Big investors, such as Cerberus and GTIS Partners, have been relentless in throwing money at the home rental business. For more on this, watch Bloomberg’s video below:
“In the first few years of conservatorship, as home values plummeted and foreclosure rates spiked, Fannie Mae drew $119.8 billion and Freddie Mac drew $71.6 billion from the Treasury to stay afloat, according to quarterly filings.”
That adds up to a $200 Billion injection of capital. In return for the money, Fannie Mae and Freddie Mac became government controlled. At first, the government asked for a 10% annual dividend on the $200 Billion, but this proved unsustainable, as the WSJ wrote. In the first year of conservatorship, Fannie Mae alone would have had to return $11.9 Billion to the government. Again, it proved undoable. The deal was changed, so that Fannie could keep $3 Billion annually, and return the rest to Uncle Sam. This has proved sustainable, and so far, the government is making out well; Propublica notes the profit for Uncle Sam is so far $46.4 Billion (they have disbursed amount slightly less than $119.8 Billion). CNBC uses the phrase “cash cow” to describe how profitable conservatorship has proven. My guess is that it won’t be any time soon that the government puts Fannie and Freddie back into private shareholder hands.