According to the Fannie Mae webpage, the Federal National Mortgage Association was chartered in 1938 “at a time when millions of families could not become homeowners, or risked losing their homes, for lack of a consistent supply of mortgage funds across America.” Sounds like today, huh? And it is.
Creditworthy borrowers, both in the mortgage and small business markets, are not able to obtain credit today due to a “lack of liquidity.” Specifically, banks are hoarding what reserves they have in anticipation of having to realize billions of dollars of losses associated with mortgage-related assets.
The resulting credit crisis has seen banks collapse, mortgage banks collapse and consolidate, insurance companies go under and the overall global credit market and interbank loan market evaporate. So what is the best approach to addressing the credit crisis? Why not restore liquidity to the markets directly?
Since the current bailout bill has failed in the House of Representatives, leading to a very scary market day today, why not look at another model. The bailout approach planned to buy the worthless and risky mortgage-backed securities held by investors and banks. This in turn is hoped to (1) provide the now almost worthless securities with a positive value and (2) make banks would feel better about the world and thus cause them to start lending again.
But this is a very indirect approach intended to protect the remaining financial institutions in their current, albeit revised forms. Why not move the emphasis from these highly unstable institutions to the market itself?
Providing some $400 to 500 billion in new mortgage authority for the provision and/or insurance of debt to creditworthy customers, either directly through a federal agency, or indirectly through insured instruments and secondary market buys, would immediately do two things: (1) inject significant capital into the market, and (2) provide some relief from the downward price pressures currently felt in the real estate market—the global factor driving the heart of this crisis.
So let’s get Fannie Mae up buying paper from good customers—customers that, at this point in time, no matter how strong their application, cannot get credit. Making mortgages available to creditworthy customers would accomplish two positive goals: (1) give them the money to snap up bargain properties in today’s low-priced real estate market (increasing the number of buyers and stabilizing prices) and (2) fund creditworthy customers instead of buying Wall Street’s losing bets (thereby increasing the likely returns to taxpayers who will be paying the bill).
Comparable funding could also be injected in the business loan sector, either through the Department of the Treasury or even the Small Business Administration. Again the emphasis would be on creating credit for creditworthy customers—not high risk customers.
Finally, to resolve the pressure on the mortgage/foreclosure sector, the government should freeze or reduce terms on ALL ARMS and fixed loans at current or the originally discounted rates for a period of six to nine months to allow Congress, the Administration (including the new President), and the markets to work through the details of where we are. This freeze should apply to all loans on the market -both those in danger and those not in danger. The reduced bank earnings for these loans would represent part of the huge price that banks should pay to offset the massive subsidy that the taxpayers are already providing.
This will provide some breathing space to work through the details of the current crisis and take the pressure off of consumers and lawmakers to cobble together a solution in a period of transition and electioneering. Congress needs to take the elections out of the process and buy time for when cooler heads can prevail.
In any case, these stabilizing steps need to be taken immediately. This crisis can, is and will continue to spread outside the financial sector. Retail sales are likely to take a huge hit this winter and all other sectors are already feeling the credit crunch. Anything less than a complete commitment to creating liquidity in credit markets will result in a serious economic meltdown—one that makes September 11th’s impact on the economy look like a hiccup.