The Fannie & Freddie Bailout: Less Than Meets the Eye

"Fannie and Freddie Offer Relief" is the headline – but is this relief real, or is it little more than taking an aspirin while losing a limb? For a coherent answer to that question, don't go to the press. The problem there is that journalists (a) think that anything new is necessarily important, and (b) don't generally understand the arcana of the market in mortgage-backed securities.

Instead, go to the blogs. Specifically, go to the incomparable Tanta, over at Calculated Risk, who has the details, including, helpfully, a link to the original source: Freddie's press release.

The main thing to note, as Tanta says, is that the market in subprime loans was $450 billion last year alone. The injection of $20 billion over a period of two to five years is not going to make a huge amount of difference. As we saw on Monday, there is a pretty liquid market in subprime loans already – and, crucially, in the subprime loans which have already been originated, rather than hypothetical subprime loans which may or may not help out borrowers in future.

The idea behind the F&F announcement is that there are borrowers burdened with toxic subprime mortgages who will, soon, face nasty resets, driving their repayment costs through the roof. Fannie and Freddie are saying that they will buy securities based not on those toxic mortgages, but rather on new, less toxic mortgages which will be used to refinance the original ones.

Nowhere, however, is any mention made of what will happen with the enormous prepayment penalites which make such refinancings extremely expensive for borrowers.

And the whole reason why many subprime borrowers are getting into trouble is that they took out loans with low initial teaser rates because those low initial rates are all that they could afford. If they're now being offered loans with more realistic interest rates, it's far from clear that will actually help.

To put it another way: the problem is not predatory lending, where banks offer loans at sky-high interest rates to mugs who don't know any better. The problem is that people are buying houses they can't afford, thanks to mortgages with ridiculously low interest rates. (At least for the first year or so.) And a new mortgage can't solve that problem.

There is some good news in yesterday's announcements, but it doesn't have much to do with the headline $20 billion figure. What Fannie and Freddie announced yesterday is important rather because it finally creates an official criterion for what constitutes a good subprime mortgage. Banks love to write loans which conform to F&F's standards, and now they can do that in the subprime market. That will go a long way to reducing the amount of dodgy mortgages being written – although of course underwriting standards have already tightened up an enormous amount since last year.

In the meantime, though, individuals facing foreclosure today, or people who live in a house they can't afford, should take little comfort from the headlines. None of this is going to help them in the slightest.