Now, US govt is giving out subprime loans

[Francois Cellier]

From DNA India

Now, US govt is giving out subprime loans

Vivek Kaul
DNA
Friday, September 25, 2009 2:13 IST


Once bitten, twice shy? Not if it's the government of the United States.

In a bizarre piece of logic, the Barack Obama-led administration has been giving out subprime loans through the Federal Housing Administration (FHA), a government agency.

Prime home loans are the best part of the market, where only borrowers with good credit ratings get a home loan. Subprime home loans are the worst, typically involving borrowers with very bad credit history and who won't get a loan in the normal scheme of things. No reiterating how the shower of such loans opened the floodgates of the current financial crisis upon us.

Why then is the US government giving out these loans again, and through a government agency? Experts say the idea may be to prop up the housing prices, which have gone on a free fall.

"It probably is to support the financing on the housing finance market and therefore housing prices generally, as well as supporting the home ownership aspirations of the lower socio-economic part of the society," says Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.

The US Federal Reserve has maintained interest rates at close to zero percent for some time now. Despite this, banks are not willing to lend.

"The US government is desperately trying to inflate the economy and it wants to get credit flowing again in order to stabilise American housing.

So, if the commercial banks are repairing their balance sheets and won't lend, then the US government has taken over this role of credit creation," says Puru Saxena, the founder and CEO of Puru Saxena Wealth Management and the editor and publisher ofMoney Matters, a monthly economic newsletter.

John Rubino, co-author of The Collapse of the Dollar and How to Profit From It, agrees: "The government is handing out newly printed paper currency to virtually anyone in an attempt to prevent a 1930s style crash."

The subprime loans issued by FHA are converted into financial securities and sold to banks. Unlike the earlier batch of subprime securities, these come with a government guarantee. The FHA currently insures loans worth a whopping $560 billion.

Worryingly, these subprime loans from the FHA require a down-payment of just 3.5% of the value of the house being bought. This means just about anybody with a little bit of money lying around can take such a loan, irrespective of whether he or she in a position to repay.

The result is for all to see. In a report released on June 18, the US Department of Housing and Urban Development, which oversees the FHA, had said the rate of default on these loans exceeded 7%. Also, more than 13% of these loans had been defaulted on by more than 30 days.

"Of course it is very risky," says Saxena. "However, politicians only care about the near-term outlook so that they can get re-elected. Who cares about the outcome 10 years from now? The bartenders are back again, giving more drugs to the addict so that the party can keep going. Needless to say, they don't care about the long-term health of the addict," he adds.

"Subprime lending should be strictly private sector, buyer beware. No government guarantees," says Rubino. Experts feel these loans will lead to another crash in the days to come.

"I am sure it will lead to another epic bust in a few years time. When central banks start raising interest rates again, then we will see another massive crash," says Das "It depends on the size and scale, but if it is government guaranteed, it will inflict losses on the government rather than on private bank balance sheets."

The irony is perhaps best expressed by Shah Gilani, a retired hedge fund manager and noted expert on the global credit crisis, in an article for DNA: "Perhaps our ultimate fate is that of the permanently punchdrunk veteran boxer who rues his decision to stay in the game, realising that he fought "one bout too many."

If that's the case, that "one bout too many" could be Subprime Crisis II, arranged by the very market referees whose job it was to protect us from such beatings."

[Francois Cellier]

From The Big Money

The Biggest Government Bailout Is Yet To Come: Itself

By Heidi N. Moore
Thursday, September 24, 2009 - 1:04pm


"If you've got me," Lois Lane once asked Superman as he flew to her rescue, "Who's got you?" We could point that same perplexed question at the U.S. government and its ranks of overwhelmed financial agencies, which are now in bigger danger than the nation's banks ever were.

It's no surprise that the $19 trillion stimulus spending spree would take a toll. While Wall Street is enjoying a giant, inexplicable bull-market rally on the back of seemingly infinite government support, the paint is chipping on the old house down in D.C. Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke are scaling back emergency lending programs like a fashionista returning expensive dresses before the credit-card bill comes due. The official gloss for the government's stimulus scale-down is that good times are coming again and we don't need to keep supporting banks, money-market funds, and private equity firms with expensive programs. Geithner soothed that we are "back from the brink," and Bernanke declared that the "recession is over." But the bigger reason the Obama administration is pulling the baby bottle away from corporate America is that the overextended federal government is now starting the slow and ugly business of bailing itself out.

You can already see the signs of bailout strain on federal agencies. The Federal Housing Administration, which insures lenders writing new mortgages, is running low on cash and is below its congressionally mandated reserves. The Federal Deposit Insurance Corp., which is funded by bank fees and has been dolloping out money to failing banks, has also dipped below its legal reserves. The FDIC may actually need those banks to turn around and save it, and could even tap a Treasury bailout despite a year of protestations about its financial health. Geithner said he would slash the government's plan to buy toxic assets from banks by two-thirds, to a mere $30 billion from $100 billion. Meanwhile, Geithner is preparing to beg Congress for an increase on the debt ceiling—a limit on federal borrowing already set at $12 trillion—which we could hit as early as mid-October because we're spending so much on stimulus plans. That's quite a sketchy bill of health for a system that's allegedly "back from the brink."

Look deeper, however, and the government isn't really quitting its bailouts at all. It is just shifting strategy away from banks and financial services to a new set of quieter bailouts, centered on the housing and real estate markets in general and Fannie Mae and Freddie Mac in particular. In this way, the administration's actions are meshing with the wishes of House financial services committee Chairman Barney Frank, who said last year, "I want at least two years with President Obama and a solidly Democratic Senate so that we can get the federal government back in the housing business." Now it is, even to the point that the government is at risk of creating another mortgage bubble. We just have to see if the government can handle it.

The government has to concentrate all of its resources on keeping the housing and real estate markets stable because the government is now the single biggest investor in mortgage-backed securities. It bought more than 80 percent of all the mortgages issued by Fannie and Freddie. What this means is that if homeowners start to fall behind on those mortgages in even bigger numbers than the current 9.24 percent default rate, the government is in deep trouble, starting with the Federal Reserve. The Fed's own balance sheet—its financial holdings—has ballooned to $2.1 trillion from just $800 billion a year ago. One-third of the Fed's balance sheet is weighed down with $625 billion of troubled mortgage-backed securities, once floating around the market and now invited to stay in Uncle Sam's own accounts.

The government is aiding the housing market in several ways. One of the biggest is the Fed's own monetary policy, which keeps interest rates at zero and mortgage rates low. Another way is a series of plans and political pressure designed to help homeowners modify mortgages. And another is a $1.45 trillion Federal Reserve program designed to buy mortgage-backed securities, many issued by government-backed Fannie Mae and Freddie Mac. The Fed just agreed this week to start winding down this program, but consider this: Morgan Stanley’s (MS) trading desk believes the Fed is scaling back on Fannie and Freddie buys because there's so little paper left. And why is there so little paper left? Because the Fed has been, all year, the biggest buyer of Fannie's and Freddie's mortgage-backed securities; the ones the Fed hasn't bought have been snapped up by enterprising traders hoping to sell the Fannie and Freddie bonds back to the government at a fat profit.

The Fed is also extending and expanding its TALF program to $1 trillion, from the original $200 billion. TALF, which stands for Term Asset-Backed Securities Loan Facility, is little-known to most taxpayers—but it's a hero to banks and is widely credited with restarting the moribund credit markets, particularly for loans backed by credit cards and autos. The program offers cheap loans to investors to buy securities and is being expanded to accept commercial mortgage-backed securities as collateral. That's no coincidence. The Fed is clearly hoping to forestall the expected crash in a market in which $1.4 trillion of loans will be maturing in the next five years.

The Fed buying government-backed mortgage bonds is a classic example of the government bailing itself out. The Federal Housing Administration got into the act, guaranteeing billions in Ginnie Mae bonds before it couldn't afford to keep up with demand from the banks. The FHA had quite a run, however, backing 23 percent of new loans in 2009, compared with 3 percent in 2006, according to AOL's Daily Finance. The Federal Home Loan Banks, a government-sponsored enterprise that helps banks make mortgage loans, has already lent so much that it is funding banks at a 10-year low. The end result has been some bizarre entrants into the federal mortgage game, offering no-money-down, fully financed mortgage loans to keep the money sluicing through the system at taxpayer expense. The U.S. Department of Agriculture, of all things, has boosted a $10.5 billion mortgage-lending program that was meant for farms but is now being used for three-bedroom colonials. What next? Will the Parks Department set up a mortgage desk?

And it's not just mortgages by which the government is trying to save itself. The U.S .government has auctioned $7 trillion of Treasuries this year alone to help fund the bailouts—$1 trillion more than it did in 2008. And who is buying all those Treasuries to help fund the bailout? The Federal Reserve, which owned $4.875 trillion of Treasuries as of March, making it the biggest holder of U.S. government debt. The Fed is also the biggest continuing buyer of Treasuries, snapping up 48 percent of the $339 billion in net new Treasuries sold as of the second quarter, according to the Wall Street Journal, and poised to dominate again as the Treasury auctions off a record $112 billion in bonds soon. In short, the Treasury is issuing bonds to fund the bailouts so the Fed can buy the bonds to fund the bailouts that the Fed helped create.

It's a toxic loop of government spending. It seems quaint that a year ago Congress was worried that a single $700 billion bank bailout would cause the government to implode. Now we are committed to trillions more, mostly in a housing market still on sketchy ground, which could turn against us any time. The government gets some credit for recognizing the danger now—and trying to pull back before it hits the debt ceiling in just three weeks. But its reductions are paltry compared with the size of its problem: the $1.4 trillion in upcoming maturing commercial mortgage loans and the trillions more in U.S. mortgages in record foreclosures. Pulling back all government stimulus would be a disaster for the markets, which have learned to seek comfort in Uncle Sam's arms. But many of these government programs were enacted hastily, work in opaque ways, and are still being badly accounted for. Perhaps we need a bailout czar.

[ninjalooter1701]

[VanishingPoint]

Originally Posted by Francois Cellier

From DNA India

Now, US govt is giving out subprime loans

I would like to see more proof that the government is doling out subprime loans. Do you have another source? I found the folllowing but it was not due to sub-prime loans:
HOUSING: Now federal loans are sinking, too

[Fredfredson]

VanishingPoint

Did you see this article I posted the other day:
US credit shrinks at Great Depression rate prompting fears of double-dip recession

F

[VanishingPoint]

Thank you!