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01.07.2002, 17:50

Fannie Mae Distorts Markets / Interessanter Artikel

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http://www.mises.org/fullstory.asp?control=986

Fannie Mae Distorts Markets

by Robert Blumen

[Posted July 1, 2002]

[img][/img] Franklin
Raines, speaking for the Bush administration, says that he is in the
"American Dream business."<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn1" name="_ftnref1">[1]</a>
Raines is chairman and CEO of Fannie Mae, a corporation whose mission is
"to tear down barriers, lower costs, and increase the opportunities for
homeownership and affordable rental housing for all Americans. Because having a
safe place to call home strengthens families, communities, and our nation as a
whole."<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn2" name="_ftnref2">[2]</a>

A prolific speaker, Raines has been touring the country to
present his view that Fannie is helping to fulfill the American dream for
millions of citizens. And as if that were not enough to justify
Fannie’s existence, Raines cites Joseph Schumpeter,<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn3" name="_ftnref3">[3]</a>
chaos theory<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn4" name="_ftnref4">[4]</a>,
and the work of the Peruvian economist Hernando de Soto to further argue that
Fannie is strengthening capital markets and promoting entrepreneurship.  

But can Fannie Mae really make housing more affordable for all
Americans, without imposing ruinous costs on some?

<h3>Fannie: The Mortgage Behemoth</h3>

Fannie Mae and Freddie Mac are quasi-private firms chartered
by Congress to create and provide liquidity in secondary mortgage markets. They
are known as government-sponsored enterprises (GSEs), a moniker that reflects
their privately owned but government-chartered and -regulated status. Together,
they purchase, retain, or guarantee more than 70 percent of the conforming
mortgage market.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn5" name="_ftnref5">[5]</a>

Mortgages are originated by retail institutions such as banks. Fannie
purchases standardized ("conforming") mortgages from the originators.
Fannie then either holds the mortgages or packages them together as securities,
called mortgage-backed securities (MBSs or"agency debt") and sells
those securities on credit markets.  Many of them are purchased by
money market funds.  

In a free-market economy with a sound monetary system, all
funds that are loaned to borrowers were necessarily saved by savers somewhere
else in the economy. The act of saving is the deferral of a consumption
opportunity from the present to the future. Savers require an interest
payment for this sacrifice. Borrowers take on the obligation to pay
interest because they value the opportunity to fund present consumption more
highly.  

In every credit transaction, there is a risk that the borrower
may not have sufficient income to fund the debt obligations. This default
risk must be borne by some combination of the two parties in the transaction. The
borrower can put up collateral, or the lender can charge a higher interest rate
to compensate for the risk. Private lenders that are risking their own
capital have a natural caution about the level of risk that they are willing to
assume.  

Fannie is a financial intermediary: It borrows from some and
lends to others. However, Fannie’s regulatory status gives it a number of
special privileges not available to private firms operating in the credit
markets. In a free market, financial intermediation is a good. Intermediaries
perform the valuable service of bridging potential buyers and sellers.   

But GSEs are not a free-market intermediary. Unlike private
transactions in which the risk is shared by agreement among the parties to the
transaction, GSEs silently transfer default risk (beyond their own meager
capital reserves) to the taxpayer through an implied government guarantee.

But that’s not all. For other reasons, agency debt is more
attractive than debt issued by private corporations. Because it has
transferred some of the default risk to third parties, Fannie is less cautious
in evaluating the default risk of borrowers than a private firm risking its own
capital would be. Another factor is that GSE securities are accorded
preferential treatment in the calculation of bank reserves, so they can be
purchased in many cases where private MBS or other forms of debt could not. And
finally, the GSEs themselves are exempt from federal and state income taxes.

Reserves are held by lenders as a cushion against default by
some fraction of their borrowers. A desire to maintain a certain reserve
ratio limits the amount of credit a lender can issue. Fannie’s costs are
reduced because its own capital reserve requirements are lower than for
comparable private firms, i.e., it is able to issue more credit with the same
amount of reserves.

Fannie’s monopoly privileges have given it an
ever-increasing share of the secondary conforming mortgage market, and it
currently is seeking to expand into other parts of the mortgage market.

<h3>The Demand-Side Case</h3>

In his speech to the Securities Industry Association late
last year, Raines breaks down the case for subsidizing the flow of funds into
the housing market into two components: supply and demand. On the demand
side, he cites a multitude of trends driving increasing demand for what he calls
"housing investment and mortgage credit": population growth, the
growth in home ownership rates, the maturing of the population into home
ownership years, increasing house prices, the trend toward larger houses with
more amenities, and the decreasing equity ratios of home loans.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn6" name="_ftnref6">[6]</a>

Raines combines these factors to calculate the total"demand"
for residential real estate investment of $11 trillion to $14 trillion over the
next decade. This is the amount that borrowers will need to borrow, given
Raines’s assumptions of price appreciation. Here, Raines raises the
specter of Yogi Berra-nomics,<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn7" name="_ftnref7">[7]</a>
a condition in which homes are so expensive that no one can afford to buy one. He
says,"From the demand side, we know that consumers will need twice the
mortgage capital to own their homes. And if the supply of capital falls
short of demand, it would only drive up the cost of housing of all types."

<h4>An Affordable Housing Bubble</h4>

Fannie gives banks the ability to lend potential home buyers
funds that they could not otherwise qualify for, with which they may purchase a
home that they could not otherwise afford. For example, the Wall Street
Journal reports that home loan mortgage payments as a percentage of
disposable income are at record levels due to"changes in mortgage
underwriting standards," and that the average down payment has declined
over the last decade >from 10 percent to 3 percent, with zero down payments
not uncommon.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn8" name="_ftnref8">[8]</a>
Fannie claims that it is using its regulatory privilege to decrease the cost of
the credit to home buyers.  

But does this make housing more affordable? The housing market
will respond to an increase in demand by some combination of increasing supply
and/or increasing prices. Research by Bert Ely, author of a study on the
GSEs for the American Enterprise Institute, has suggested that subsidizing
mortgage loans does not do much, if anything, to make housing more affordable
because most of the subsidy goes into price increases rather than supply
increases. His research shows that only a small increase in home prices is
necessary to fully capitalize the interest rate subsidy.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn9" name="_ftnref9">[9]</a>

Ely’s research also indicates that a portion of the demand
subsidy goes toward an increase in the size of homes.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn10" name="_ftnref10">[10]</a>  Ironically,
it is this increase in home size that Raines cites as another factor driving
demand for its lending activities.

The GSEs have linked home prices to the market for risk-free
debt securities. Domestic and foreign buyers purchase these securities. In
fact, they are a significant fraction of the capital accounts surplus funding
U.S. the trade deficit. Fannie’s continued ability to find buyers for
riskless debt securities allows it to create what appears to be an increasing
demand for housing by magnifying the amount of systemic risk.

Most home owners are completely unaware of this process,
believing instead that their home prices are driven by the factors similar to
those Raines cites, and that home prices move in only the upward direction. This
process is not unlike the way small investors approached the stock market
during the stock market bubble.

The fallacy of Raines's demand-side case for subsidized
mortgage credit is that when a demand subsidy exists, home prices are
partially a byproduct of the demand subsidy. Raines's claim that Fannie is
simply stepping in the gap to supply much-needed credit is disingenuous.
Increasing home prices are partially a consequence of Fannie’s credit subsidy. Of
Raines's list of so-called drivers of credit demand, most are side effects of
the leverage and declining credit quality that Fannie has created.

If Fannie’s policies enable some buyers to obtain loans
credit that they could not otherwise afford, then for them, the cost of buying a
home will be lower--"more affordable." As Raines has claimed in
one of his speeches,"The suggestion that too much capital is going into
housing is not new. We heard it a lot in the beginning of the 1990s. Fortunately
for the 10 million families who became homeowners during this decade, the theory
did not get much traction."<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn11" name="_ftnref11">[11]</a>

It is not surprising that the recipients of a subsidy were
pleased with the result: demand for a free good  always exceeds supply. The
borrowers, the banks, and Fannie’s shareholders are quite happy with this
arrangement. Taxpayers will probably remain unaware of their obligation
until the bill becomes due. Were interest rates to rise, housing prices to
turn down, or the ratio of mortgage loan defaults to increase beyond Fannie’s
reserves, a taxpayer bailout reminiscent of the S&L bailout would probably
be called for by holders of GSE debt.

<h3>The Supply-Side Case for Affordable Housing</h3>

Raines is aware of the argument that supplying subsidized
funds to housing diverts resources from other, more productive uses. For
those skeptics who aren’t convinced that funding a housing bubble by
transferring the risk of Fannie’s credit pyramid to the taxpayer is a good
thing, Raines has been reading Peruvian economist Hernando de Soto’s book, The
Mystery of Capital.

De Soto writes that,"the single most important source
of funds for new businesses in the United States is a mortgage on the
entrepreneur's house. These assets can also provide a link to the owner's
credit history, an accountable address for the collection of debts and taxes,
the basis for the creation of reliable and universal public utilities, and a
foundation for the creation of securities (like mortgage-backed bonds) that
can then be rediscounted and sold in secondary markets. By this process the
West injects life into assets and makes them generate capital." 

When nations don't have this"representational process,"
he says, their assets--including their homes--become what he calls"dead
capital." 

And therein lies the supply-side argument for more capital
flowing into housing. Housing in America generates capital. It creates and
broadens the distribution of wealth--not only the wealth of individuals, but
also the potential wealth of nations. And as a capitalist, I believe that is a
good thing.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn12" name="_ftnref12">[12]</a>

Raines has seriously misunderstood de Soto’s argument. De
Soto is making a case for the importance of enforceable property titles. Without
property titles, there will be individuals who have funds that they would be
willing to lend, for some rate of interest. There will be others who would like
to borrow in order to start or expand a business.  

The entrepreneur always faces a risk of business failure.The
borrower could reduce this risk to the lender’s principal by putting up some
of his own property as collateral. The lender will be unwilling to accept this
type of collateral if the property does not have a clear title because such a
contract would not be enforceable. Even if the aspiring entrepreneur wanted to
sell his possessions outright to raise the funds, he would have a harder time
selling without transferable titles. Without clear titles, credit transactions
will only occur where there is a high degree of personal trust between the
parties. In the informal economy that de Soto has studied, possession may be the
only form of title that exists.

De Soto’s work shows that when a country establishes a
system of enforceable and transferable titles, there is a tremendous benefit: credit
transactions between unrelated individuals become much less risky. This opens
the possibility for many borrowers and lenders to participate in mutually
beneficial exchanges, and eventually, for anonymous exchanges through capital
markets. Thus potential entrepreneurs with some assets to their name can more
easily raise funds.

Raines completely misunderstands that de Soto’s thesis is a
point about the legal system, not an argument for a greater quantity of funds to
be allocated to any particular sector of the economy. Because the United States already
has a system of enforceable and transferable property titles to real estate,
this systemic benefit has already been realized here and is no longer available.
All homes in the U.S. already have clear and transferable titles attached to
them. And there is a well-developed system of title insurance in place
to protect against errors in titles or unforeseen claims. Home owners already
have the ability to buy and sell their homes or borrow against them. There is no
additional systemic benefit to be realized by creating a system of property
titles in the U.S.

<h4>Defining Capital</h4>

The use of the term"capital" by both Raines and de
Soto is the source of some confusion. From an Austrian perspective, capital (in
the economic sense) consists of those goods that figure in the production
plans of entrepreneurs.<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn13" name="_ftnref13">[13]</a>
Production consists of using the factors--land, labor, and capital--to produce
more capital or consumption goods. Capital has value only because of its ability
to contribute to the ultimate production of consumption goods. Capital goods are
the intermediate products of time-consuming production processes. Some examples
of capital goods are factories, machinery, semiconductors, and oil tankers.

In a complex economy, each of the various steps in production
processes can be performed by different individuals or firms. Firms base
their decisions to produce on anticipation of the value of their product in
relation to the final, consumed goods that will be produced. Capital goods have
value only because of their contribution to goods that a consumer is willing to
pay for.

The creation of capital must be funded out of savings, because
those who produce capital goods need to consume something while they are
producing something else that is not, itself, for consumption. Savings is the
abstention from a possible consumption opportunity. Those who save and invest
are transferring their command over consumption goods to the producers of
capital goods.

People often use the word capital to refer to money that can
be invested in a business venture, or money that changes hands in the markets
for capital goods, known as capital markets. While money can be spent to
purchase factors of production (of which capital is one), money is not itself
capital in the Austrian sense. The term loanable funds is a better way of
describing money that a lender is willing to loan to an entrepreneur.

<h4>The Confusion of Capital</h4>

In the passage that Raines quotes, de Soto is using the term
capital to mean any asset that has value. A careful parsing of Raines’s and de
Soto’s statements is required to arrive at a consistent understanding. A home
is an asset, and it is wealth, but it is not capital in the economic sense;
i.e., it is not a good that is an intermediate artifact of a time-consuming
production process. Housing is a consumption good. True, it is a durable
consumption good, and it may rise in value over time for many reasons, but it is
not capital.

De Soto unfortunately uses the term capital to mean credit, or
loanable funds. De Soto’s point can be restated:

In an economy without enforceable, transferable property
titles, potential entrepreneurs have difficulty borrowing funds because they
cannot secure the loans, due to their inability transfer the title.

In an economy with enforceable, transferable property titles,
entrepreneurs can use assets as collateral with which to secure loans of
loanable funds. The entrepreneur can then use the borrowed funds to purchase
or lease land, labor, and capital as part of their production plan.

Raines is claiming that when Fannie provides more loanable
funds to home buyers, more capital is created, thereby increasing the scope for
entrepreneurship and economic growth. Here, Raines is guilty of confusing
loanable funds and capital. Fannie’s subsidies and special privileges allow it
to extend credit at a lower price than it otherwise would. This
risk-shifting attracts more loanable funds into housing than otherwise would be,
but does not increase the amount of real capital in society. No savings has
taken place nor have any new capital goods been produced.

If Raines were really interested in increasing the amount of
capital, the funds that Fannie loaned to the home buyer could have been loaned
to an entrepreneur to fund real investment. If that is the goal, what
benefit is there of first loaning the money to a home buyer, who can then borrow
against his home? Fannie and other intermediaries may profit from this sequence
of exchanges, but that is not to be confused with more savings or the production
of more capital goods.

As chronicled by numerous observers of the current financial
scene,<a title href="http://www.mises.org/fullstory.asp?control=986#_ftn14" name="_ftnref14">[14]</a>
Fannie funding is increasingly used for"cash-out" refinancing and
home equity loans, the proceeds of which are spent to pay down credit card debt,
or to fund more consumption items. The long-term result of increasing
consumption at the expense of savings investment is that capital is consumed
without being replaced. An economy with less capital can produce fewer
consumption goods. Overall wealth is diminished.

<h3>Conclusion</h3>

An economy grows, i.e., increases its ability to produce
consumption goods, when people save enough to fund the accumulation of more
capital. Thus, wealth creation depends on savings. This is the only real way to
make most things more affordable for the bulk of the population. Only the
accumulation of more capital goods will enable business firms to produce more
consumption goods.

<div>

Raines may be in a dream business, but the net result of
Fannie Mae’s actions in the credit markets is a nightmare of resource
misallocation and massive systemic risk.

<hr align="left" width="33%" SIZE="1">
</div>

Robert Blumen is an independent software consultant based in
San Francisco. Send him MAIL.

<hr align="left" width="33%" SIZE="1">
<div>
<div id="ftn1">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref1" name="_ftn1">[1]</a>
Quoted from Raines’
biography.

</div>
<div id="ftn2">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref2" name="_ftn2">[2]</a>
http://www.fanniemae.com/initiatives/index.jhtml?p=Initiatives.

</div>
<div id="ftn3">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref3" name="_ftn3">[3]</a>
See
the speech.

</div>
<div id="ftn4">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref4" name="_ftn4">[4]</a>
See
the speech.

</div>
<div id="ftn5">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref5" name="_ftn5">[5]</a>
"Critics:
Fannie, Freddie Grip Mortgage Market," USA Today, May 21,
2002.

</div>
<div id="ftn6">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref6" name="_ftn6">[6]</a>
Franklin Raines, speech
to the Securities Industry Association, November 8, 2001.

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref7" name="_ftn7">[7]</a>
The great Austrian economist Yogi Berra once said:"Nobody goes there
anymore; it’s too crowded." http://www.yogiberraclassic.org/quotes.htm.

</div>
<div id="ftn8">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref8" name="_ftn8">[8]</a>
Stretched Buyers Are Pushing Mortgage Levels to New Highs, Wall
Street Journal, June 12, 2002.

</div>
<div id="ftn9">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref9" name="_ftn9">[9]</a>
GSEs
of Federal Policy: Public Benefits as Instruments and Public Costs,
Bert Ely, pp. 5 and 8.  See also Neither
Fish nor Fowl: An Overview of the Big-Three Government-Sponsored Enterprises
in the U.S. Housing Finance Markets, Jay Cochran III and Catherine
England, p. 38.

</div>
<div id="ftn10">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref10" name="_ftn10">[10]</a>
Ely, p. 9.

</div>
<div id="ftn11">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref11" name="_ftn11">[11]</a>
Raines, SIA speech.

</div>
<div id="ftn12">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref12" name="_ftn12">[12]</a>
Raines, SIA speech.

</div>
<div id="ftn13">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref13" name="_ftn13">[13]</a>
Microfoundations and Macroeconomiocs: An Austrian Perspective,
Stephen Horwitz, Routledge (2000), p. 45.

</div>
<div id="ftn14">

<a title href="http://www.mises.org/fullstory.asp?control=986#_ftnref14" name="_ftn14">[14]</a>
See, for example, Doug Noland’s weekly column, The Credit Bubble
Bulletin, on www.PrudentBear.com.  See
also Jim Puplava’s Financial Sense web site, The
Last Wave.


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Popeye

01.07.2002, 18:48

@ JüKü

Re: Fannie Mae Distorts Markets / Interessanter Artikel - Ergänzung

WASHINGTON, July 1 (Reuters) -
The U.S. regulator that oversees
the finances of mortgage finance
giants Fannie Mae FNM.N and
Freddie Mac FRE.N is considering
Securities and Exchange
Commission-type reporting
requirements for the companies, it
said on Monday.

The regulator, the Office of Federal
Housing Enterprise Oversight, told
a senior White House official it is
considering a new regulation to
boost disclosure requirements for the mortgage financiers. OFHEO was
responding to a May White House request for tighter rules for the
companies.

OFHEO said it is considering requiring periodic reports based on what is
currently required of SEC-registered companies.

The regulator said it is also considering requirements that the
companies register their offerings of stock and debt. But it said it would
try to find an approach to securities registration that would not impede
the companies' financing needs.
Quelle: Reuters

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