The "Fixes"

Thu, Nov 25, 2010 - 9:08am

It’s not just the Bush tax cuts that expire at the end of the year. The maximum lending limits at Fannie Mae, Freddie Mac and FHA were set to expire. The Build America Bond (“BAB”) program is another. They both have been “fixed”. We kicked the can down the road (again) while no one was looking.

Way back in 2008 when we were really in a financial crisis there was no private mortgage market. The banks were all in the crapper and they were not lending a dime. Without a viable mortgage market there would have been a complete collapse. The maximum lending limits of the D.C. mortgage providers were set at levels designed to support the bottom end of the housing market. In response to the crisis the HERA legislation allowed for a very significant, but temporary, increase in the statutory lending limits. Those temporary increases were supposed to be reversed as of 12/31/2010. They weren’t reversed. They were extended.

These critically important extension of federal subsidies to the mortgage market were lumped into a number of other fixes necessary to keep the government moving for another year (Sen. Byrd’s grandchildren get $197k?). The language that “fixed” the problem can be found at this site. The specific wording is at the bottom, in sections 143-146. There was no debate on this. Washington just passed the trash.

The Bond Buyer reported on Wednesday that BABs were going to “fixed” as well. The BABs program is another child of 2008 and the HERA stimulus program. The history is not unlike the Agency debt limit issue. In 2008 there was not much of a Muni market left. States were being locked out of the credit markets. Without capital they could not fund projects. The BABs legislation created a new security to allow the states to tap a different capital market. States were permitted to issue taxable bonds. These bonds had higher yields than traditional Muni bonds as they were not tax protected. To offset the cost, the Treasury department is reimbursing the states for 35% of the interest bill. With the federal subsidy the states were again able to issue debt.

Two years later the Muni market is in much better shape. But it is still on weak legs and D.C. desperately needs the states to spend money to support the economy. So the BABs legislation will be extended for another year. The municipalities are issuing billions of long-term bonds under the program. The federal subsidy will be doled out for 20 to 30 years as a result.

I don’t think there was much choice in the extensions of the emergency steps taken back in 08. If mortgage limits were dropped in the key area on both coasts from the ~$750,000 limit back to the pre-emergency levels of ~$450,000 the real estate market would collapse. Should that have happened we would have been in a deep dark recession in just a few months.

Similarly, we would be dead if the Muni market shut down. If state borrowers were forced to pay fair market rates for debt, they would not borrow. As a result they would not spend. Deep cutbacks in key states would have followed. Unemployment would shoot up in that scenario. Absent the BABs program a number of states/cities would have been forced into insolvency.

Folks, we are on life support. We have been since 2008. Nothing will change in 2011. QE has been extended, the tax cuts will be extended, BABs and the Agency loan limits are being extended. The IV is full and inserted into the arm. The juice that is keeping us alive is still flowing. But make no mistake about this. Without the IV the lights will go out very quickly. 2011 is the last year for these extensions. When we wake up to the fact that we are alive only as a result of medicine we take on a daily basis there is going to be another “event”.

Some say that legislative gridlock is a good thing for the markets. History suggests this is correct. 2011 may prove an exception to the rule. There are too many things on the plate.

Speaking of which, enjoy that other plate that is front of you today.


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