How Much Do We Have to Pay Fannie and Freddie Execs to Lose Us Billions?
Apparently we have to give them more than $200 million in bonuses to give them enough incentive to lose taxpayers billions of dollars. The NYT says that 213 employees are slated for bonuses of more than $100k each and the top paid ones will pocket over $1 million.
That seems like a lot of money. After all, can't we pay a high school kid the minimum wage to throw away taxpayer dollars. Just to be clear, I'm not referring to the money that was lost on their prior loans, I'm referring to the money that they are losing on the loans that Fannie and Freddie are buying every day.
Fannie and Freddie continue to buy loans that were used to purchase homes at bubble inflated prices. These loans will go bad at very high rates, because the prices will plunge and the homeowner will then be underwater. Underwater mortgages are very likely to end in foreclosure or short sales.
The easy way to avoid issuing loans that are likely to lead to large losses is to base valuations on appraisals of rent. If Fannie and Freddie refused to approve any loans that could not be justified based on a multiple of 15 times the annual appraised rent (with some regional variation), then they would substantially reduce their loss risk.
Note that this policy would help, not hurt, homeowners. We do no one a favor by encouraging them to buy a home at a bubble inflated price. They end up paying more in housing costs each year that they live in the home and they likely end up with a foreclosure or short sale when they leave the home, or at the very least losing whatever equity they put up.
I argued repeatedly with the chief economists at Fannie and Freddie about the existence of a housing bubble in the years 2002 to 2007. I would think that we no longer need to have this argument. Unfortunately, Fannie and Freddie are still making loans as though they haven't noticed the bubble. It is hard to justify six and seven figure salaries for this level of incompetence.
[I almost forget to mention the boards of directors of these government owned companies. Board members at Freddie get paid $160k a year. I assume that the salaries at Fannie are comparable. That's pretty good pay for government work, especially since the directors probably only put in a few weeks a year of work. And, these are not especially astute people. Several of them slept through the original bankruptcy of Fannie and Freddie.]
That's what GM will do in the near future too - make compact electric cars even if nobody buys them. Somebody will tell them what to do, in both cases. And guess what - no pitchforks over bonuses.
April 4, 2009 2:16 PM | Reply | Permalink
Enough of this Fannie/Freddie bashing.
The Wizard behind the curtain is Barney Frank. Fannie and Freddie don't put on their socks without asking him what color he prefers that day.
April 4, 2009 2:23 PM | Reply | Permalink
without asking him what color he prefers
Wasn't that a weekly reality show on Bravo? I loved that show, what happened to it?
April 4, 2009 11:34 PM | Reply | Permalink
Baker, can you keep it simple for a change? Assessing what any given person will pay to rent any given property, to determine a buying value, over an entire market, is just a bureaucratic nightmare. Not to mention arbitrary.
You are going to have to accept the fact that you cannot protect people from themselves on a case by case basis. Nor can you perfectly predict a house value or a buyer's ability to keep up payments. Why not just require 20% down payments for everybody?
It's not politically correct, but so what. It immediately separates the able from the wannabes.
As for bonuses, claw them back. When did Government jobs come with bonuses? Bonuses for Congressional staff? What's up with that?
April 4, 2009 7:05 PM | Reply | Permalink
Shooter,
there is no bureaucratic nightmare here. Fannie and Freddie require an appraisal accompanies every mortgage that they buy. They just change the rules to make the appraisal based on annual rent rather than sale price. This is so simple that even a multi-million dollar banker can figure it out.
April 4, 2009 8:42 PM | Reply | Permalink
Oh please. Just the idea that one shouldn't evaluate the value of a house, by comparing it to actual sales of similar houses is just absurd. Anything else is fraud.
Are you going to base the value of a house in the burbs on the nearest apartment complex? How many homes get rented period? How does a lease negotiated a year ago reflect the sale of a house today? In this market it doesn't.
Look, I understand that you want to protect people from bubbles, but you can't. Human nature is responsible for market fluctuations. There is no way you're going to change the propensity for people to chase rising value. Adding more distortions to an already distorted market certainly doesn't help.
You also can't stall creative destruction resulting from bubbles bursting. Sadly, citizens are bearing the brunt of deleveraging rather than the banks and their governmental overseers, but that's politics in our day and age. You did your part, and like it or not you'll have to sit back and watch the market do it's thing. At least you can do that with a clear conscience. Just let it go.
April 4, 2009 10:01 PM | Reply | Permalink
Shooter,
I think it's wonderful if people want to throw their money in the toilet, but I want to prevent the taxpayers from being forced to do so.
Rents followed fundamentals, not the lunacy of the people who ran Citigroup and the Fed. I can design a very simple method for getting rent based appraisals. I realize that most of the people who get 6 and 7 figure salaries aren't that smart, but that is no reason to throw trillions of dollars in the garbage.
April 4, 2009 10:32 PM | Reply | Permalink
April 5, 2009 9:26 AM | Reply | Permalink
The issue of compensation is tied to the overall larger issue of corporate governance. This is a joke. Stockholders are usually asked to approve the preselected candidates for the board of directors. If there is any mechanism for proposing outside directors it is totally ineffectual.
So stockholders, the "owners" of a firm, have no real way of controlling the firm's behavior. Saying that one can always sell one's shares if one doesn't approve, as libertarians often do, is not a real solution. Every major firm is run the same way. I should add that most non-profits are even worse since their boards are self selected without even the pretense of an election.
Even in the rare occasion when a stockholder proposal passes, boards have taken to ignoring them saying that they are only "advisory".
If stockholders actually had any say in the running of their companies there might be some regulation of the excesses. Changes in governance rules requires the intervention of government, but elected officials get their campaign funding from these very same firms. Catch 22.
Democracy is broken, not just in government, but in public institutions.
April 4, 2009 7:56 PM | Reply | Permalink
Shooter - Dean has correctly grasped an applicable solution to one of the key drivers of the entire crisis - valuation. Ask an appraiser for more detailed description, but there are three approaches to valuing a home: cost basis (how much does it cost to build it), comparable sales (how much do similar homes sell for) and income basis (how much it's worth based on local rents).
Right now, the best approach to weight when valuing a current home is what you can rent it for. This is the case whenever there are rapid changes (up or down!) in both housing sales (due to foreclosures pushing down prices or irrational demand pushing them up) and construction costs (due to a sudden drop in demand or sudden increase). Renters, unlike buyers, don't face pressure to get deals done from anywhere other than the property owner, or face pressure to foreclose during down times.
I'm not saying you eliminate using the sales comp or cost approach - just sharply reduce the weight. Finally, and this is something Baker didn't suggest, is the buyer, not the lender or seller, ought to be able to engage the appraiser. Right now it is the lender, and FIRREA or not, both the lender and RE agents who refer deals to lenders have incentives to get deals done, and end up with appraisers who get the numbers to "work".
April 4, 2009 10:45 PM | Reply | Permalink
Dr. Baker started off discussing how the geniuses at Fannie Mae and Freddie Mac are to be compensated, a question which seems to me to lie at some distance from real estate values in South Succotash TX. I was going to leave it alone as over my poor Liberal Arts head, but then I immediately came across the following on the op-ed page of the Wall Street Jingo:
(( That's from Titan of Economics #14,209(B), Neocomrade M. Feldstein of H*rv*rd and Rancho Crawford. ))
Now if I understand trendy Chicagonomics correctly, one decides whether ScroogeBank is well managed or not depending on how much it is worth on the stock exchange, it being the divinely revealed duty of Big Management to enrich shareholders -- and to do nothing else on the side that distracts.
Assuming that shibboleth is ideologically correct, does it apply to miscegenated public-secret entities like Fannie and Freddie? I have no idea, but it does look that IF it DOES apply, then the geniuses' bonuses ought to be based on the value of their corporations' mortgages rather than the value of the buildings mortgaged.
If I am still have not off the rails somehow, the final puzzle is exactly what M. Feldstein means by 'although'. He sounds (to me ignorant) as if a high probability of default does not much matter before the default actually happens. Does that make any sense?
___
One could at any rate start again from scratch by asking the general question of how mortgages, rather than houses, are to be evaluated, in case M. F. is hushin' something up or I have misunderstood him somehow.
Happy days.
April 5, 2009 9:11 AM | Reply | Permalink
Oh please. Do rising prices in the art market produce a crisis? No. The driver in this crisis was decoupling mortgage sales from mortgage holder risk. Just like CDS sales were decoupled from CDS risk.
Housing valuation is a symptom, not the disease. That's my problem with Baker's idea. Quit pussyfooting around the real causes and address the politically incorrect truths of inflating demand via artificially enlarging the homebuyer pool with reduced lending standards. You can't argue that 20% down wouldn't have prevented this.
April 5, 2009 9:56 AM | Reply | Permalink
Shooter - You are right about the cause - the current house mortgage crisis was caused by the decoupling of mortgage sales from mortgage holder risk. A minor league banker told me that about 20 years ago. He told me that when banks first quit holding their own mortgages, when they started packaging them for sale to institution buyers. He said it would develop into a huge proplem. Just like the Old Testament, the prophets usually prophesy a generation or more before the fall.
April 5, 2009 10:52 AM | Reply | Permalink
Shooter is right.
We need higher down payment standards. That alone would have stopped a lot of the housing bubble.
The problem is, high lending standards mean that a lot of people cannot buy a house, and owning your own home has become sort of a fetish over the past ten years or so.
Moreover, there is the fact that tougher loan standards will disproportionately prevent non-Asian minorities from owning their own homes. A lot of what drove this bubble was an unwillingness to make lending standards more harsh because it would be seen as racist.
April 5, 2009 11:23 AM | Reply | Permalink
"Do rising prices in the art market produce a crisis? No."
We don't live in our art, and not everyone owns pieces that compose the majority of their net worth, unlike homes.
"The driver in this crisis was decoupling mortgage sales from mortgage holder risk. Just like CDS sales were decoupled from CDS risk."
This is only one of the drivers, and I might agree that it is one of the bigger ones. There was a confluence of events leading to the collapse and there are more cards: deregulation; elimination of Glass-Steagall provisions; collapse of the stock market bubble, leading investors from stocks to "safer" investments; declining interest rates due to expansive Fed monetary policy after 9/11; slowly eroding bank lending standards (I watched this personally - one company I worked for did not, and one did - guess which one is still around); short-term profit focus; executive compensation policies; and more.
"Quit pussyfooting around the real causes and address the politically incorrect truths of inflating demand via artificially enlarging the homebuyer pool with reduced lending standards."
You're correct here as this is one of the big factors. I don't think it is politically incorrect - it came from profit motives as well as the decoupling of risk, pressure from the sales team and sales management, and short term profits. There are those that argue that CRA caused this, but it was so easy to get satisfactory ratings after the Bush admin began, it was a non-issue in both banks I worked at. I can't speak for FNMA or FHLMC as I didn't work there. Did you? Or do you have direct knowledge? If so, by all means, comment!
"You can't argue that 20% down wouldn't have prevented this."
Not arguing that.
From a cleanup point of view, we need the most accurate way to value the underlying assets, not the derivatives, at the banks. Then we know just how insolvent they are and which ones are the worst.
We can deal with stock market bubbles. We don't live there. We can deal with art bubbles. Don't live there either.
The bottom line is people who bought homes in the last 5-6 years have seen a big chunk of the money they put in their homes go away. Poof. There are so many of us in this group, as a whole, we stopped spending money on anything but necessities, and that's the core issue.
April 5, 2009 5:47 PM | Reply | Permalink
Most people who bought overpriced houses sold overpriced houses. And the vast majority of those who didn't put nothing down -- thus, they've lost nothing.
Or to say it differently most people are back where they were in 2003 -- neither better nor worse off for the experience except for those who cashed out equity to pay for that shiny new Hummer or that trip to Cancun to relieve all that stress.
Let's not overstate the calamity.
April 6, 2009 12:06 AM | Reply | Permalink
There is a curious item in yesterday's FT:
Who modifies their mortgages to increase the payments?
For completeness, the point of the piece was that prime mortgages had the highest increase in the rate of default.
April 5, 2009 7:14 AM | Reply | Permalink
If house prices were not inflated, then we could have had zero down loans forever. the issue was the bubble pure and simple. If we had the same bubble and every loan carried a 50 percent down payment then we would still be in pretty much the same situation when it burst. Homeowners would have seen a loss of $8 trillion in wealth.
That is the root of the problem that is killing the economy. The cry baby billionaires who run the banks of course want us to keep throwing tax dollars at them, claiming that this will fix the economy, but the core problem is the loss of wealth. At the end of the day, we can send wall Street off into the East River and the economy will do just fine.
April 5, 2009 4:47 PM | Reply | Permalink
If house prices were not inflated . . . . Homeowners would [not] have seen a loss of $8 trillion in wealth.
Most of the "$8 trillion" was paper "wealth," only. Now, its gone, and for most people it's like the last five or six years never happened. So, what's the big deal?
It's time to return the creditors to where they were in 2003. And if those savvy creditors don't like it, they can take it up with Ace Greenberg, Jimmy Cayne and Warren Spector, Richard Fuld, Lloyd Blankfein and Henry Paulson, Hank Greenberg -- well, they'll know who to talk to recoup any real losses they may have suffered over the past half decade.
April 6, 2009 3:08 AM | Reply | Permalink
Now, its gone...So, what's the big deal?
That would be fine, for people who never took money out of their equity.
However, *guy on radio says 7 trill in mortgages written between 2001 and 2006. That money got spent, so that now when the underlying "wealth" is gone, there is a new debt burden to service in its absence.
*An unimpeachable reference...
April 6, 2009 4:08 AM | Reply | Permalink
Actually, I'm not that big on saving the Cancun vacationers and the had-to-own a Hummer MEW types, but ---
Write their debt off, too. If the creditors were stupid enough to loan them money against their manic, ephemeral paper wealth, too bad for the creditors.
Even so, I have this sense that the creditors created the "wealth" (Dean's $8 trillion) out of thin air and that they won't actually be losing anything real but the fees and commissions they foolishly paid to the banks and to their financial managers.
April 6, 2009 4:31 AM | Reply | Permalink
The creditors funded the bubble and thus, are responsible for its existence; they should be compelled to experience the effects of the bubble's subsequent deflation, fully, and ought not be permitted to benefit from its prior existence.
What I'm searching for is an accounting equivalence to express that notion.
April 6, 2009 4:41 AM | Reply | Permalink
accounting equivalence
I believe you will have to seek elsewhere than the world of accounting.
April 6, 2009 5:09 AM | Reply | Permalink
too bad for the creditors
Well, of course, I welcome the new regime of "too bad for creditors".
April 6, 2009 5:11 AM | Reply | Permalink