BluefoxToday blog : October 2008

When the government took over a few months ago the two giant mortgage industry players there was a collective sigh of relief in the housing market. Up until that point they had been struggling under severe liquidity problems and were ready to collapse. If that had happened the residential real estate market would've faced even more serious problems besides falling prices and decreasing sales.

They are now managed in a government conservatorship by a newly-created entity Federal Housing Finance Agency. After the takeover both were injected with a $100 billion credit facility behind which the U.S. Treasury stands, so the money is pretty safe. The purpose of the action was to bring stability to the highly volatile mortgage market and it is starting to have a positive effect. A certain degree of uncertainty still prevails but things seem to be on the right track.

Fannie Mae and Freddie Mac are now able to do what they were so successfully doing before, namely purchasing assets and guaranteeing mortgage-backed securities. They have the means for it and are instructed to fully engage in this support task. Actually, strings have been loosened a bit more as they are even urged by FHFA to become creative. Yet, knowing what excessive innovation in mortgage products just did to the market, hopefully they understand where the limits are.

Storm clouds were gathering over these institutions already some time ago but the regulators chose not to intervene at that time. If they had, the current volatility might be of softer variety. But obviously political and regulatory forces were not in alignment to do anything about it until there was no other course. No one was willing to make tough decisions when they were needed.

The government has tried over the last year or so quite a few different ways to stem the flood of new foreclosures. The rework idea hasn't fared too well, however, as the numbers keep going up at a steady pace. The programs that have come out of Washington have been voluntary on the mortgage industry with some financial incentives thrown in but that evidently hasn't been enough to make a meaningful impact on the problem. The previous belief that a foreclosure is very expensive to the mortgage holder doesn't seem to be valid any more. If it were then these plans would've worked out much better.

The main sticking point appears to be the securitization of mortgages, the rules governing them and those who own these securities. The securitization, in simple terms, means that individual loans were first combined into pools of various sizes which then were sold to trusts and investors would buy a slice of the trust. That's how pension funds, central banks and investment firms got involved in the mortgage business.

To modify any number of these loans mortgage servicers would usually need two-thirds of the investors to go along with it. That is clearly easier said than done. Moreover, in a given trust reworked paper would naturally cause some investors to incur worse losses than others. Another tough nut to crack. And the servicers themselves frequently make more money in foreclosure, so their enthusiasm toward modification is minimal.

For the workouts to make more headway something obviously has to change. It points toward adjustments to the rules and regulations governing these trusts and/or the foreclosure process itself. Whatever is done will certainly set off loud howling in some circles, predictably a host of lawsuits, too.

Therefore, to arrest the slide in property values should be right on top of the agenda in any discussion. The home and its value is the collateral that all these home loans lean on. Owner-occupied homes will keep price levels pretty steady in any neighborhood and that ought to be encouraged. Foreclosures, on the other hand, have the opposite effect and hurt everybody. In the long-term even investors would likely benefit more from a market that is stable, with a price structure that is sustainable. But it looks like they are, the investors, for now at least, taking the short-term approach to this.  

The media is all over the map describing in sweeping headlines how the American and international financial systems are on life support. Central banks across the globe are pumping all sorts of cash into their respective banking sectors to stay ahead of the advancing wildfire and keep the entire inter-connected financial network from collapsing. It's important news, of course, and has caught consumers from Las Vegas to Washington in this tantalizing development.

There is at least one sector in the U.S. financial system that is presently surprisingly stable, though. It's the mortgage business. True, it does have some issues to deal with like painfully high foreclosure numbers and tighter underwriting guidelines but when it comes to having capital available to make home loans, it's there.

It's possible because Washington has practically taken over a large share of the industry through its institutions Fannie Mae, Freddie Mac and FHA. They have an easy and cost-effective access to international capital markets thanks to having the U.S. Treasury guaranteeing whatever they do there. At least for now the mortgage trade is pretty much controlled by the government but under these trying circumstances its involvement was necessary. Without it the besieged real estate market would be now wallowing in muck thigh high.  

Mortgage rates are still very attractive and those with decent credit can get a home loan. An FHA-insured loan can be acquired for 3% down and Fannie Mae and Freddie Mac have programs requiring only 5% down. Those are good, low numbers. And what also is uplifting is that many of the once over-heated markets, like Las Vegas, are seeing prices in full retreat and that is bringing buyers out to look for bargains.

Today, despite the spectacular roller-coaster activity on Wall Street and banking deep freeze the mortgage market is holding its own and open for business.

The extensive financial, or housing and mortgage, rescue program in its present form is clearly designed to first lift Wall Street off the mat. Details are still being worked out in Washington on it but that's where its main focus is. Some say that this direction is ill-advised, though. Among the heavy hitters supporting that is the Chairman of FDIC, or Federal Deposit Insurance Corp., Sheila Bair who just voiced her displeasure the other day.

In the center of the dispute is the belief that the key problem now is the number of foreclosures that still keep on rising in many states. If homeowners were able to make their mortgage payments the banks wouldn't be in such a mess and therefore more should be done to help borrowers out. The cycle of defaults begins on the street level and spreads from there up to the lenders and institutional investors. So, pouring billions into wobbly financial institutions is largely missing the point.

There is another point to be made here. Real estate values continue to deteriorate in multiple areas, including in Las Vegas, and is mainly the result of all these foreclosures flooding the marketplace. As values drop, people are more likely to walk away from their homes and the underlying mortgages become less and less valuable and that will hurt banks and mortgage lenders even more.

The argument as a whole does have some merit and ought to be considered as the bailout plan is being implemented. This is no longer only a subprime issue either. An alarming portion of better quality mortgages is now going bad, too.

For months solar energy proponents have been trying to pass in the U.S. Congress a bill that would extend the existing tax incentives. At least that and perhaps even improve on them. What's in the books now will expire by the end of the year and it appeared as if the desired extension wasn't going to happen. The fossil fuel energy producers form a powerful lobby and obviously they stood in the way.

But as Wall Street so splendidly disintegrated and Washington needed to quickly get a bailout package passed, solar supporters decided to try one more time and managed to slide a new extension provision into the bill. And the rest is history. It's a done deal and all of a sudden it gives new life to the industry. Senator Reid from Nevada, long known to be a solar advocate to help his state and the country with energy issues, is rumored to be one of the main catalysts to get this thing passed.

Homeowners buying rooftop solar sets will get a 30% tax credit for eight more years. Besides that, the previous cap of $2,000 was amended and now it could go much higher. If a rooftop solar system is installed at a cost between $25,000 and $30,000, that's about the average for one, the tax credit now approaches $9,000. That is a significant hike and ought to spur more interest in the concept. Given the current mortgage and real estate turmoil many homeowners probably have their sights aimed at other issues at this point but once the market improves, the industry should be ready to take off in a big way.

Commercial firms that install solar systems will enjoy the same 30% tax credit for another eight years. The current investment tax credit was also extended by eight years and should help reduce the cost of developing solar technology and thus eventually bring grid parity to the market. This means that electricity produced by solar means costs the same as fossil-fuel generated power. Indeed, some experts predict that it could take place as soon as 2015. From there on solar could really cruise into the mainstream as the power of choice.

States that currently have a solid base of solar energy manufacturing are the ones that will benefit the most, at least in the early going, from the extension's passage. According to Navigant Consulting they are Arizona, California, Florida, Massachusetts, Nevada, New Jersey, New Mexico, New York, Oregon and Washington. Right now around 60,000 people are working in the trade, reports Solar Energy Industry Association, and with the extension that number is expected to rise quite a bit.   

The answer is maybe. Time will tell what its short- and long-term effects are on the battered financial sector. The first read indicates that Wall Street wasn't all that impressed as it dropped 157 today after the measure was approved in Washington. There are many skeptics about its potential to cure the ills that were mainly caused by irresponsible mortgage lending practices on all levels and speculative real estate investments and schemes.

For one, everyone should have taken more time in putting the complex plan together. A week or two isn't anywhere near enough time to come up with a comprehensive, well thought-out blueprint for a massive project like this. Congress did hold off the initial Treasury request for a quick approval, mostly motivated by politics, which would have been by many accounts disastrous. The delay did give those who were aiming at a broad-based, responsible outcome to get some kind of a handle on what they were supposed to do. Yet, as it now stands, there seem to be a gazillion details that still need to be worked out and that leaves the door open for all sorts of abuse and mayhem. Haste is the enemy of lasting solutions.

Some of the measures appear to be taking the plan in the right direction, toward restoring confidence in the financial arena and also protecting the taxpayer who is footing this mammoth rescue bill. Federal agencies, supposedly meaning Fannie Mae and Freddie Mac, can modify mortgages in distress. Details on this won't be known for at least a few weeks but it could become a helpful outlet for many struggling homeowners.

A must point was to get an oversight function for the entire effort. Without it the Treasury Secretary would've been pretty much the only authority calling the shots and that would've been potentially very hazardous. After all, he is the one who has been watching the marketplace come unglued for the last several years and didn't have the capacity to correct it. How could anyone trust him to fix it now? Hopefully it has all the needed power to act in the best interest of the taxpayer. And the government can through warrants get equity positions in companies so that if and when bailed-out firms have future gains taxpayers will also benefit from that.

As more details are worked out in coming days and weeks, the picture will become clearer and preferably will yield true results.