Saturday, July 12, 2008

Of course, perhaps we should just let the GSEs die

A Businessweek article contends that perhaps the US should just put F and F into conservatorship and let them eventually die. In conservatorship, their existing securities would be guaranteed, but they wouldn't issue new ones. Plenty of foreign investors bought these mortgage backed securities, seeking higher returns than US Treasuries, but with the element of safety. Guaranteeing the debt would be good foreign relations.

However, the fact that so many foreign investors were interested, and were willing to throw cash at these securities meant that effectively, cash was flooding into the US housing market. The easy availability of cash to write mortgages meant that underwriters - like banks - got sloppy. It fed the whole subprime mortgage segment, which used adjustable rate mortgages to take advantage of low US interest rates. The problem was, when interest rates went up, delinquencies mounted, and the US subprime sector self destructed even more spectacularly than Britney Spears. The capital influx also fed a spiral excessive homebuilding. While the US homebuilding industry hasn't Britney Spearsed, it's having dire troubles with excess capacity. Houses are sitting unsold. People aren't interested in buying or aren't able to get a mortgage.

The article, as well as the Morningstar video I linked in my last post, contends that one possible route is to nationalize the GSEs. Without the incentive to produce excess returns for shareholders, all they would have to do is generate enough money to fund their own operations, which would be doable once the market stabilizes. The small government folks will wail and moan, but it's one possible route. Whichever option is chosen, neither firm can be allowed to go under overnight.

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