Tuesday, March 09, 2010

The Fannie/Freddie Targeted Tax Cut

Economists are baffled to explain why consumer spending hasn't dropped more given the severity of the depression. Of course government unemployment and stimulus are part of the answer, however there is another. Many people are now living rent free. I want to be clear that I am not passing any judgement on those that are - just pointing out the fact that they have stopped paying on their mortgage and now have that money to spend on other things. Ordinarily this wouldn't have a net-positive affect because a mortgage payment is simply a transfer to the individual (or entity) that loaned you the money in the first place. In this world of securitization your mortgage payment could literally be made to your next door neighbor who owns a Freddie or Fannie Mortgage Backed Security....Let me explain.

Let's say your neighbor loaned you the money to buy your home, each month you walk across the street and drop off a check. You have just spent $1,500 or more on your mortgage, your neighbor received it and we'll pretend she lives on it and proceeds to spend the money. Now, let's pretend that you stopped paying your mortgage, but you still lived in the house. You've stopped making the monthly trek over to your neighbor and rarely go outside in order to avoid the confrontation. You now have that $1,500 to spend (maybe you don't, perhaps you've lost your job, but you've probably got something to spend that would have normally gone to the mortgage). Your neighbor on the other hand is out $1,500 per month of income - this is money that WILL NOT BE SPENT as it isn't ever paid. Why is this important? Because for the those holding Fannie/Freddie debt, it isn't happening. In our scenario when you signed your loan docs with your neighbor to buy your home, your neighbor was smart, she bought insurance from Fannie/Freddie (technically she sold the loan in return for the payments coming from Fan/Fred). So now when you fail to make your payment to your neighbor, she doesn't care - Fannie/Freddie, AKA the government and taxpayers will pay her (so you can now have your neighborhood BBQ). This is what happened when the government put Fan/Fred into conservatorship and then gave them an unlimited line of credit - they made up for the lost mortgage payment so that your neighbor continues to get and spend her money.

I'm not complaining about this, other than the fact that it is my taxpayer money going out (okay, complaining a bit). My point is that spending is also being propped up by these transfer payments. Fannie and Freddie are AIG on steroids. Everyone knew that Fan/Fred was government backed - EVERYONE - which is why Fan/Fred was able to borrow at such low rates. Allowing Fan/Fred to fail would have been a complete disaster - mainly because of the collapse in spending and transfer payments this laundering system provides. Fan/Fred was not a mortgage entity - they were an insurance company that no real reserves. Actually they had massive reserves - the taxpayer.

Let's look at the situation again, people have stopped paying their mortgage and have that money to spend now (or at least some portion), many of the people that were receiving the mortgage payments that would normally stop receiving the mortgage payments have continued to collect via the government insurance policy, thus they continue to spend - there you have it, a major targeted tax cut that continues the spending. Next time you wonder why nothing is being done about Fannie and Freddie - remember, its all about spending.

So what is my solution? I've discussed it several times, but housing has to be looked at in a comprehensive fashion and everyone has to participate in certain losses in order to move on. First, second mortgages have to be addressed - they are the main obstacle in fixing the housing problem. Second, principal reductions must occur, even if it is some form of tradable debt/equity swaps. Third, we need to begin removing the government from housing.

There is much more and I'm not suggesting that we allow Fed/Fan to default - the government created those messed up companies and they must take responsibility for them. They should be accounted for ON-Budget and we should have a plan to fix, break-up and then make it illegal for the government to bail them out ever again. None of this will happen, so housing will continue to falter.

Scott Dauenhauer CFP, MSFP, AIF

(Please forgive the poor grammar, spelling mistakes and disconnected thoughts.....I've got a busy day today and just needed to get this posted!)