The Fannie and Freddie trade is back
49 comments
·January 8, 2025muglug
I hope Matt Levine is well-capitalised because he’s pretty-much the only reason I subscribe to Bloomberg
otherjason
If you or anyone else are interested, his newsletter is available by email for free!
AnotherGoodName
Note that the majority of bad 2008 loans were from a spike in financial business lending not personal lending.
https://en.m.wikipedia.org/wiki/Subprime_mortgage_crisis#/me...
You’ve probably heard of private equity buying companies, loading them with debt, transferring money to the parent and bankrupting the company and wondering why banks give loans to private equity when we know this playbook. Well the bank loans are guaranteed ultimately by Freddie/Fannie. There’s no risk here and everyone but productive members of society win here. It’s still ongoing too.
kasey_junk
What are you talking about? Fannie and Freddie don’t buy loans for businesses other than some commercial real estate. They certainly don’t back most private equity plays.
jarsin
I encourage anyone thinking of following Ackman to look up all the shenanigans he played on investors with his Spac.
He essentially leveraged the massive pile of money from Spac investors to buyout UMG for his own fund. Leaving the Spac investors high and dry with no ownership. He keeps making those investors empty promises about some future deal to this day years after the Spac folded.
Ackman only puts out stuff like this public if he needs retail to give him leverage on some angle he has.
nayuki
Relevant quotes from the article:
> 2. Banks lend people the money to buy houses, but the government encourages them to do so by guaranteeing the loans.
> 3. Banks lend people the money to buy houses, but someone else guarantees the loans. There’s a big Mortgage Guarantee Company ... Mortgage Guarantee Company is a regular public company, owned by shareholders, but it is a large good safe company with sterling credit. And the Mortgage Guarantee Company is carefully regulated by the US government to make sure that it is well capitalized and safe, so banks will happily rely on its guarantees. They’re not government guarantees, but they’re AAA-rated, government-regulated guarantees, almost as good as the government. The government, in this approach, is not providing a financial guarantee, but it is putting its seal of approval on the Mortgage Guarantee Company’s guarantee, saying “you should trust this guarantee almost as much as you would trust our guarantee, because we endorse this company and regulate it carefully.
> The approach that the government settled on for many decades was “mostly 2, but kind of really 3.”
I like Matt Levine explicitly spelling out these details. Why? Because many people in the general public, especially leftists and socialists, believe that the 2008 Great Financial Crisis was caused by greedy US banks lending out money to unworthy people who had no ability to pay back loans, and take a profit from each transaction, and sell the toxic debt to other parties. It's a story directly attacking the greed and corruption in capitalism.
While those 3 points in the story are true, what this ever-popular narrative misses out is that the banks were motivated to make these loans because someone else - FMAC and FMAE - guaranteed them. And FMAC and FMAE basically have the full backing of the US government. The banks weren't risking their own money if loans fail; they were risking someone else's money. If the banks were the ultimate underwriter of these mortgages and thus defaulters would impact the banks, then the banks would've been way more diligent and restrictive about loaning out the money. So in the end, this is more a story about socialism and government interference that underlies the capitalistic greed. The bad loans were subsidized by the public at large, and that is a good example of socialism in practice.
scarface_74
Default of conforming loans was partially caused by people who could afford to keep paying their mortgage deciding it wasn’t worth it because the value of their houses was so much less than their loan, they decided to do a strategic default.
The prices of homes were inflated by investors overpaying for homes and non conforming loans that were not government backed.
There were a lot of tricks that investors and home buyers could play. I was involved in investment real estate and had my first house built between 2001-2005.
The first and easiest non conforming process that wasn’t government backed was to take out two mortgages - 90/10. I had a my first house built a 2500 square foot home and only put $1000 down. The cost at the time was $175K mortgage and the value of the house went up to $205K before the crash. It was also an interest only first mortgage.
I refinanced it before the crash to get fixed interest rate and had a HELOC for $30K
While one investment property I bought was 10% down, it also wasn’t government backed.
The second investment property not only was done 100% financed because I knew people by then, it was also valued by a bank appointed appraiser at an unreasonable high price, I overpaid for it and the seller gave me cash back for the difference. I knew this was shady. But I later found out that this was illegal.
They also took my word for it that I had enough income from my other investment property to cover the mortgage.
By 2008, I was making $70K from work and had five mortgages totaling around half million.
By late 2012, I walked away from all of them. The value of all three houses put together were worth $250K.
Exactly three years after the last foreclosure to the day, I got approved for a mortgage of $335K FHA and had my house built - 3200 square foot 5 bedroom 3.5 bath in 2016 with 3.5% down and 3.5% interest rate. I just sold it last year for $670K
The house I had built in 2003 and walked away from in 2012 just got back up in value to the price I paid for it in late 2018 and the price I refinanced it for in mid 2020. It sold for $270K last year.
The bank bailouts were because banks were making a lot of risky non conforming non government back loans and as investors like me started walking away from houses, the economy crashed and people saw it made no sense to try to keep their homes, they walked away.
> The banks were the ultimate underwriter of these mortgages and thus defaulters would impact the banks, then the banks would've been way more diligent and restrictive about loaning out the money Banks also lied about the credit worthiness of loans in their portfolio when they sold them off
That’s just the thing, as soon as the banks made even non conforming non government back loans, they bundled them, lied about the credit worthiness of the loans and sold them off - mortgage backed securities. They weren’t ever at risk.
The banks servicing the loans were not the original underwriters
abduhl
I assume you were in a non recourse state? Your strategy as I understand it would only work in a non recourse state.
scarface_74
Two of the mortgages for one investment property were sold so many times, we were able to negotiate a short sale. The first mortgage short sold for $27K when I owed $120K and the second mortgage negotiated a pay off for $1000 on I believe around $25k.
For my home back then, the second mortgage didn’t ask for anything and I believe I was able to negotiate around $10K and the short from what it was sold was around $50k.
The fifth mortgage I never heard anything back. I think it sold for around $50K less than owed in foreclosure.
My backup plan was bankruptcy. I had a place to stay and all of my assets were in my protected retirement accounts.
dehrmann
> Because many people in the general public, especially leftists and socialists, believe that the 2008 Great Financial Crisis was caused by...
This is a lot like the cost of college and student debt load. A large cause was unlimited, government-backed loans. With buyers who weren't price-sensitive, colleges started competing with each other on things like amenities, and there wasn't a mechanism to say "maybe a $200k loan for an art degree isn't worth it."
nayuki
Correct. A lot of free market distortions can be explained by bad government policy. In your example, when the government funds and backs student loans, colleges can treat that as a free cash machine to extract as much money from students as possible. Also, note that student loans cannot be discharged in bankruptcy, so the lender can't lose! Whereas if student loans were made by for-profit banks without government backing, and with the possibility of discharging in personal bankruptcy, we would see way more prudence in how money is lent out. After all, you (the bank) are way more careful with your own money than with someone else's money (government insurance/guarantees).
And speaking of free market distortions, one of my favorite example is externalities, e.g. pollution. If the government doesn't charge a price on pollution (e.g. carbon dioxide), then obviously every business would pollute as much as they want because it's free. The polluters impose a cost onto other people - e.g. health, loss of human productivity, cleanup costs, loss of land value.
tzs
I'm not convinced on government backed student loans. I haven't been able to find much data on college costs going back well before government backed loans started, but for the couple of schools I found data for (Stanford and some midwest public university whose name I don't remember) that data showed tuition has been going up at a fairly steady rate for the last 100+ years. There was no significant change at those schools pre and post government backed student loans.
viraptor
> student loans cannot be discharged in bankruptcy, so the lender can't lose!
They can still lose - the borrowing party may never earn enough to repay fully. Or may just stop paying for many reasons.
datavirtue
It only works because the interest is amortized out to term and front loaded so that investors can distribute almost the entire mortgage payment to shareholders immediately. If the home owner pays for five or ten years you are golden. If they default you get the principle back from the loan guarantee/foreclosure and you move on and do it again. This is why MBS REITs can pay such amazing dividends.
wrfrmers
>Because many people in the general public, especially leftists and socialists, believe that the 2008 Great Financial Crisis was caused by greedy US banks lending out money to unworthy people who had no ability to pay back loans, and take a profit from each transaction, and sell the toxic debt to other parties.
Most of the people that I've seen taking this position were conservative, free-market capitalists, giving themselves a little "Bad, me!" slap on the wrist. The leftists and socialists are well-read enough to know that the reason loans were backed the way they were is because the regulatory apparatus has been wholly captured by financial players, from regressive legislator campaign funding to the revolving door at regulators, and everything in between. Further, the fallout from 2008 hit most Americans so hard because insitutions leveraged this "in" to warp the shape of the federal and monetary response to the crisis in order to make them whole at everyone else's expense - a course that was not explicitly called for in law (and that some would say, in many cases, violated the duty of responsible parties to uphold the law). The problem remains the banks.
bloomingkales
Let me add my own analogy:
Imagine a fund with a 100 people in it that need a 100k each to goto medical school. What are the chances all 100 people become doctors? Who cares.
Tell people you have a fund with DOCTORS in it. Woah, a whole fund of doctors. Bundle all the loans given to the med students into a financial instrument that you price at it 5% more. Sell off the financial vehicle, remove the liability of human failure (yall ain’t all gonna become doctors).
Collect my 5% profit, do that shit again, at scale.
Hope all those doctors become doctors, I personally don’t care. Ya feel me?
nayuki
> Sell off the financial vehicle, remove the liability of human failure
Why would a buyer want to take that fund off your hands? Why do they think the fund will generate good returns and you sold it to them at a good price? What is guaranteeing/backing the fund?
Just because you declare an asset for sale, it doesn't mean buyers magically appear to take it from you - especially not at the price you're hoping for. The buyer must personally expect a higher value from the asset than the price you set.
steveBK123
Typically loan packagers use some law of large numbers type math to at least make the marketing attractive enough. Obviously this can blow up (see: 2008 GFC: MBS, CDOs, CDO^2, etc).
The attraction to investors is something like - doctors are paying 7% interest on their loans, government 10~30yr treasuries are yielding 4.5-5%. Individual doctors have a much higher risk of defaulting than the US government. If you pull 1000s of them together, some will still default but you need like 30%+ of them to default for the increased yield to not reward you for the risk. For certain types of investors (pensions, insurance companies, etc) having something that pays a little more than "risk free rate" without taking on too much risk is a big benefit.
Someone who knows fixed income more than me may chime in with lots of other nuances like early repayment risk, forbearance, re-financing, loan modifications, etc but this is the general framework.
And the guys structuring these things make money off commissions on sale, making a market between buyers&sellers of these products (the spread) and probably some some sort of management fees.
bormaj
The buyer of that pool of loans will be an institutional investor with an allocation for that kind of risk. Depending on the state of the market, the pool might be sold at a discount or a premium which may attract/deter certain investors.
Separately, pooling loans generally makes the aggregate product less sensitive to default risk because you're talking about many loans instead of just one.
pessimizer
> Why would a buyer want to take that fund off your hands? Why do they think the fund will generate good returns and you sold it to them at a good price? What is guaranteeing/backing the fund?
With the hopes of selling it off to the next guy for more. There's nothing backing crypto either.
These are rational hopes, because a lot of people played that game of hot potato and got rich. And in the end, the government bought all of that trash at par and nobody went to jail.
I worked in auction-rate municipal bonds when the (first and last) auction failed. People thought they were going to jail. They knew they had been selling garbage. And to little towns for their teacher's retirement funds at that.
forinti
In a socialist country, you would have a government entity (backed by a public bank) build houses and give them to workers or sell them at a loss or with subsidised interest rates.
This is purely a misguided (maybe corrupt) government policy in a capitalist country.
Workaccount2
In socialist countries housing is a cost that provides almost no benefit to the productivity of the state. Because of that there is strong incentive to build the absolute minimum to house the working class.
See Soviet and Mao apartments. Shoeboxes with shared bathrooms and kitchens.
forinti
I think you might be mixing up different things.
Some housing in the USSR had communal kitchens and bathrooms because they were actually older buildings adapted to house more families (hence the "you'll have to share your house" horror stories told in the West). Other buildings were actually meant to be temporary but lasted more than planned. Most of the housing of the Soviet Union was just plain apartment buildings; the flats might be small by some people's standards, but that was dictated by economic constraints.
I don't know much about China, but I know some regions had multi-family buildings with shared facilities before the revolution. These too were dictated mostly by economic constraints.
pjlegato
In a socialist country, you would have a government entity building various qualities of housing.
The best houses in the best locations go to the nomenklatura, to the governor's cousin, to the nephew of the town party boss, and to black market operators who are capable of providing large bribes to those who decide housing allocations.
Normal people live three hours outside the city center in a low quality concrete highrise.
wrfrmers
In a word, "gentrification."
(Yes, I know, I'm making a point, ye who lives in the United States of "It's not what you know, it's who knows you.")
forinti
All human enterprises are prone to our simian failings.
santoshalper
1. It's Fannie and Freddie, nobody uses the acronyms, but if you must it's FNMA and FHLMC.
2. The mortgage meltdown started with subprime loans, which were not guaranteed by Fannie and Freddie. It was private lenders selling loans to clients and then selling the mortgage-backed securities on the private investor market.
3. Fannie and Freddie were not under federal conservatorship at the time. They were regulated by the government as government sponsored entities (GSE) but were corporations with shareholders and profit motive. The regulation under the Bush administration was extremely lax. There was no FHFA or CFPB.
4. The real damage happened between 2001-2006. That's when option ARMs, pick-a-pay loans, and NINA/SISA (no documentation) loans were being made. The fact that these loans would age poorly was well understood in the industry. It was just assumed that continually rising property values would offset how genuinely terrible these loans were.
5. After the clusterfuck, Fannie and Freddie were brought into conservatorship by the federal government to prevent a repeat, and it has largely worked. The quality of mortgage paper is much, much higher than it was 20 years ago.
Yes, it was 100% stupid greed. And to be clear, nobody learned the lesson. The Trump administration is going to defang CFPB and probably bring Fannie and Freddie out of conservatorship. Another mortgage meltdown is a predictable outcome of this and I would expect it around 2032.
steveBK123
Real estate pumper president pumping real estate seems like a very likely outcome yes.
bormaj
> And to be clear, nobody learned the lesson.
This is not true. The mortgage lending pipeline is quite different today compared to pre-GFC. There is considerably more due diligence required by lenders and banks in order to back loans. Conventional loans backed by the GSEs these days have a much higher quality control. If the originating lender lied to push the loan through or didn't due diligence, they'd be on the hook for paying the defaulted principal.
> The Trump administration is going to defang CFPB and probably bring Fannie and Freddie out of conservatorship.
I'm not aware of any chatter on the former and the latter is becoming discussed quite frequently. Though I'm not sure the GSEs are interested in a GFC 2.0
> Another mortgage meltdown is a predictable outcome of this and I would expect it around 2032.
These days I would be more concerned about private credit than the mortgage market...
nayuki
Thank you, that was really helpful in correcting my understanding.
fredgrott
that is not how those securities work....if you buy such a security you are betting on your own disaster...
How?
When you buy what is called A tranches it always has a layer of toxic non A tranches....
Once housing repossessions rose above 8% all housing mort securities were under water....
great_psy
I think a lot of conspiracies people have are out in the open, it’s just that they are hidden behind articles that take 30 minutes to read and understand.
WorkerBee28474
As they say, the devil is in the details.
alecco
Maybe it's a good trade. But if it's not, Ackman and all the other snakes will get out of the trade well before you. Stay in safe money markets with decent yields. Don't swim with sharks.
everybodyknows
Some history may be useful here. In the first weeks after the 2016 election, on similar speculation, FNMA doubled in price. A few months into 2017, it crashed back down.
https://archive.ph/AyyVE