The Treasury Department is considering a plan to halt the slide in home prices that would lower mortgage rates using Fannie Mae and Freddie Mac. The plan could reduce rates for newly issued loans to as low as 4.5%. Slowly, but surely, the government is moving in the right direction. It is beginning to dawn on Treasury (albeit, belatedly) that a prerequisite for economic recovery is not just the stabilisation of the banking system, but some sort of program which provides mortgage relief for home owners. This plan is a small start.
I have a problem with this though. It is “trickle down”.
The Treasury is looking for the incremental buyer, in this case the U.S. government, to push the rate down by their buying but this isn’t the same as renegotiating the rates of existing loans.
And, Treasury doesn’t know that just because they start buying that the spreads won’t increase or some other factor comes into focus and the rates don’t go down by the desired amount.
Of course, the Fed could buy longer dated treasurys and force rates lower, as Bernanke proposed the other day in Congressional testimony.
While this proposal may be a good first step, it isn’t comprehensive enough and isn’t direct enough. Why doesn’t government start with jawboning the banks to reduce their outsized margins even at the expense of shareholders? How is it possible that banks are demanding 500 bp margin for variable rate loans? This is the 180 degree polar opposite of the teaser rates back in 2003. It constitutes yet another example of Bush managing things to the benefit of a small group of high end constituents. It doesn’t appear that Congress as a body is smart enough to figure out how to call him on it or doesn’t want to bother during the lame duck period.
On another very important note, I made a serious miscalculation in an earlier posting, regarding the savings on the at least $2 trillion of variable rate loans that I think (don’t know for sure and it may be much more) are out there. This doesn’t diminish from my proposal but the savings would be “only” say, 3-4% of $2 trillion or $80 billion rather than the hundreds of billions that I had first calculated. I apologise for the bad figures. But the concept still stands. Equally significant, there is no out of pocket cost to the government. In fact, as I indicated in my earlier post, if Fannie and Freddie make the loans they could make 200-300 bp of positive carry which could be a very large number if it continued for more than a few years.