Real estate and the federal government

Timothy Geithner, the current Secretary of the Treasury, pledged at a recent congressional hearing to reform the way Fannie Mae and Freddie Mac operate. Geithner thought Fannie and Freddie had been more prudent than the private market mortgage lenders but acknowledged mistakes. He said the failure of Fannie and Freddie in 2008 was part of a broader crisis and revealed structural flaws in the entire housing finance system. The main flaws were seen to be insufficient regulation and enforcement of existing rules and regulations.

The Vice President and Liaison to Government Affairs of the National Association of Realtors, Vince Malta, mostly agreed with Geithner. Malta thought the basic structure of Fannie Mae and Freddie Mac were flawed. He saw them having a private profit structure but a public loss structure, putting money in the pockets of those in charge but taxpayers on the hook for losses. Instead, the entities should be self-sufficient and price risk effectively to cover potential losses. Any profit should be used first to establish capital reserves.

Fannie and Freddie were allowed to earn private gains for many years while at the same time being subsidized by taxpayers. Federally regulated banks are required to hold 4% capital against mortgages on the balance sheets. Fannie Mae and Freddie Mac were only required to hold 2.5 percent capital against held mortgages and only 0.45% against guaranteed mortgage derivatives. They made unwise risk decisions during the boom years by investing heavily in mortgage derivatives.

The Federal Home Loan Bank system also made unwise decisions. Heavy investment in sub-prime mortgage securities was part of their game plan as well. These risk decisions and lack of capital reserves to cover loans and securities gone bad are a large part of the present problem.

Everyone involved thinks the government needs to stay involved in the home lending industry. Federal government loan guarantees are seen as the only way out of the housing mess. Without some sort of government guarantees the private mortgage industry would shrink to the point of uselessness. The question is: how will things be restructured and will that really solve the problems that were exposed during the past few years?

How the bank bail-out could have worked

We are now well over a year into the bank/financial institution bail-out. Trillions of dollars of taxpayer money have gone to huge companies that knowingly took very foolish risks with other people's money in order to enrich themselves. The people whose money was lost have gotten nothing and by government decree have been forced to give even more. Meanwhile the foreclosures roll on and more and more lives are ruined.

The entire mess started with home owners unable to afford the increased monthly payments on the adjustable rate mortgages(ARM's) their broker or bank talked them into(probably many could barely afford the low introductory payments). Facing the possibility of that many mortgage defaults the banks got nervous. Then the mortgage insurers(AIG, etc...) got nervous. Then the companies backing and depending on the insurers(Lehman, Goldman Sachs, etc...) got nervous and the whole house of cards started to come down.

Since the problem started with individual home owner's inability to meet an increased monthly mortgage payment, shouldn't the solution start there also? How many people would have remained in their homes and current on their mortgages if the government had offered them a few hundred dollars per month until a refinance solution could be worked out by congress and the banks? Would everyone have been so panicked if all those mortgages were getting paid by the government? Would simply keeping peoples' mortgages current have been any more expensive than the actual bail-out? How differently would our government be seen if all those trillions of dollars had been used to keep people in their homes instead of keeping huge, greedy companies afloat?

It is too late this time but this or a similar problem will happen again in the future. Next time I hope our government has the backbone and the common sense to look for solutions that address the real cause of the problem. The current financial crisis was not caused by huge banking and investment companies facing bankruptcy. The current crisis was caused by home owner’s inability to pay escalating monthly mortgage payments and this cause was never adequately addressed by any part of the bail-out.