Contrarian thinking about the mortgage agencies

The irony of the "subprime" situation, it seems to me, is that we probably all would have been better off if the GSEs had gotten into it in a big way. If the GSEs had been able to create a market in "vanilla" subprime–fixed rates, no prepayment penalties, careful documentation requirements, competitive pricing–and forced their seller/servicers into a "subprime box," the subprime loan market would have been a lot better off. The "pseudo-Maes and Macs" have never really been very good at providing the kind of market discipline within their purview that the real Mae and Mac have. But we wanted "innovation" and "choice" and "flexibility," not domesticated subprime and "alt" financing with low margins, uniform loan terms, and front and side airbags.

Here is much more, very interesting throughout.  You can add Matt Yglesias, Atrios, and now Tanta at calculatedrisk.blogspot.com to the list of bloggers calling for nationalization.

Comments

Given the market that subprime represents a vanilla subprime loan probably would have a high enough coupon (500-600+bp above treasuries)that it wouldn't have any takers. The risk is high enough that the rates would have to be at a level that almost everyone could figure out that owning a house wouldn't be a good deal. It was only when the very high actual rate was deferred or hidden (via partial repayment) that sub prime loans were actually obtained).

I'm with Tanta, that the GSEs went as far as their bylaws (and further than prudence) would allow. It seems nonsensical that they should have gone further, with worse loans, and that somehow would have made subprime better.

These are loans that never should have been made. Who made them is of somewhat lesser importance.

Slippery slope.

Nationalization always fails, and brings countries down with it.

Let's say the climate turns cold ... things could get nasty.

From the article quoted:
"If the GSEs had been able to create a market in "vanilla" subprime--fixed rates, no prepayment penalties, careful documentation requirements, competitive pricing--and forced their seller/servicers into a "subprime box," the subprime loan market would have been a lot better off."

But low documentation requirements were a defining feature of subprime loans. And the subprime market could not function without prepayment penalties - as subprime borrowers made regular repayments and their credit scores improved, they would be able to refinance at lower rates elsewhere, so without prepayment penalties subprime originators would find their more reliable customers refinancing and leaving while their less reliable ones stayed, which would push the interest rates they charged even higher.

superheater- EXACTLY!

ZB,

There is always more to speculative bubbles than just overleveraging,
although that also seems to be a nearly universal accompaniment to
serious bubbles. The rising prices feed expectations that such
increases will continue, which expectations then justify the
overleveraging, as well as drawing it forth as buyers cannot afford to
buy the bubbliciously overpriced assets without overleveraging.

The S&L crisis and this current mess share one trait. Government allowed people to keep profits while offering support against loss. People will take greater risks if they know they can keep the gains and the government will step in if things go wrong. That isn't free markets, that is stupid.

It is ironic that when Fannie & Freddie burnout, the guy called upon to shill for them is Krugman, who has gone on record numerous times about how much he loathes suburban sprawl, a phenomenon which would not manifest itself absent a market tampering effected by the quasi-governmental subsidy of housing put in place by the dangerous duo. Delightful!

Is Krugman misusing "market discipline"? To me, market discipline is the antithesis of moral hazard. It's the risk of loss and bankruptcy from non-commercial behavior. Market discipline is not "provided" so much as it is experienced. Accordingly, IndyMac is now suffering (limited) market discipline where as Freddie and Fannie are being spoiled rotten by their sugar daddy, the American taxpayer (not that I have a better idea just at the moment).

Krugman view, government regulations kept Fan and Fred from being in even worse shape by blocking movement into subprime market.

Alternative view, subprime market was under served and firms stepped in to fill the void. Absent government regulation, main stream lenders could have cherry picked home borrowers (as opposed to real estate speculators). Speculators would still have gotten loans but at what rate? Would the rate more accurately reflect the risk for the lender (or the final bond holder)? Would more stigma have been attached to these loans and would the secondary market have demanded more of a risk premium? Would the assumption that as a group these loans were safe be subject to additional reviews and greater caution?

Questions, why did housing prices get so inflated in some markets and why was the risk of these loans so wrongly priced? Was it a market failure or did government regulations distort behavior?

it is not bad paper

It must be a long time problem

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