Obama Refinance Plan Sows Seeds for Another Bailout

Great post by Mark A. Calabria of Cato.

"I’ve already mentioned how the rumored Obama plan to re-finance existing underwater Fannie/Freddie loans with new mortgages at as low as 4 percent would not actually do much, if anything, positive for the economy. Even worse is that such a plan would likely require a massive infusion of taxpayer dollars into Fannie Mae and Freddie Mac.

First let us start with some basics about the Fannie Mae business. According to Fannie’s most recent 10-Q (see page 28), Fannie’s current interest-earning assets, mostly mortgages, yield the company 4.59%. However, Fannie has to fund those assets. The cost of Fannie’s total current interest-bearing funding is 3.99%, leaving the company a spread of 60 basis points to cover its non-interest expenses. What should be immediately obvious is that lowering the value of much of Fannie’s book to 4% will leave the companies with almost zero earnings. I’m not sure how that is supposed to get Fannie back on the path to repaying the taxpayer.

Worse is that newly re-financed 4% mortgages, or mortgage-backed securities, would remain on Fannie’s balance sheet for years (assuming Fannie is still around). I cannot be the only one who believes rates are going up in the future — either due to inflation or the Fed raising rates to fight inflation. It is not hard to imagine, in say two years, Fannie stuck with a balance sheet of 4% assets, while having to pay 5% to fund those assets. It is also not hard to believe that the taxpayer would get stuck making up the difference. On a $3 trillion balance sheet, that’s $30 billion. Add in Freddie and you’ll get another $20 billion or so. And that’s at future funding costs of 5%. If Fannie’s funding costs hit 6% in the next few years, we could be looking at an annual shortfall of $100 billion.

Instead of helping dig Fannie and Freddie into a deeper hole, Obama should start offering a real plan to help repay the taxpayer for what they’ve already had to shell out for Fannie and Freddie."