Giants of US Housing to Fire 2018 Market
And so the year continues to wind down. Not so much the financial markets!
US stocks hit new highs in their final trading session last week.
Our stock market should get a lift from the positive news out of the US.
The second set of bitcoin futures are now due for trading too.
People and money continue to pour into the crypto market.
But today’s Daily Reckoning leaves those two behind for today.
There’s an important story that nobody else in the world will tell you about.
I feel dutybound to point it out before it sinks without a trace into the news cycle…
Two key planks in US housing to stay
It’s not flashy. It doesn’t mention blockchain or staggering percentage rises.
It has to do with the old-fashioned housing market in the US.
Here’s the big story: Fannie Mae and Freddie Mac are going to stay in business.
I’ll do my best to explain. We need to go over a bit of history to see the importance of today’s story.
Fannie Mae and Freddie Mac are two huge mortgage finance agencies in the US.
These two institutions have been an integral part of the US housing market for decades.
Their job is to promote home ownership in America. Part of how they do it is buying and rating mortgage bonds.
It’s why Americans can get access to a fixed-rate mortgage for 30 years.
Imagine several New York banks — just to use an example in one state — finance some housing loans in their local area.
They can keep those loans on their books as income-earning assets.
Or they can sell these loans to Fannie Mae or Freddie Mac. This allows the New York banks to reinvest their money by offering more loans.
Nice cycle, right? More loans generally equals more access to credit for more people.
Fannie Mae or Freddie Mac can keep these New York loans for their own portfolios and earn the income as the loans are paid back.
Or they can bundle these loans up with some others, give the package a risk rating, and sell a ‘mortgage-backed security’ on to other investors.
Imagine a pension fund that’s looking for a steady income stream, and you have an idea of the type of buyer.
All pretty much bog-standard banking stuff so far.
Let’s go back 10 years for a moment, when the subprime crisis hit in the US.
That was not a good time to have high exposure to US housing loans.
Fannie Mae and Freddie Mac were caught in a vicious spiral as many of the mortgage bonds they owned or had guaranteed were collapsing in value.
The US government had to bail out both Freddie and Fannie to keep them from going bankrupt.
Both Fannie Mae and Freddie Mac were known as ‘government-sponsored’ institutions prior to the global financial crisis.
If you’re confused by this term, so was everybody else. Basically it meant Fannie Mae and Freddie Mac weren’t full US government agencies, but were perceived to have the US government backing them up. It was all a bit fuzzy.
The US government used Fannie and Freddie to give housing loans to minority groups and low-income earners that, in hindsight, was bad economics but good politics.
It pushed the home ownership rate up, for starters.
When the crisis hit, the US government was left with little choice but to take the two companies into complete US government care.
Shareholders got wiped out, but the two companies lived on.
Their profits are still going to the US Treasury to pay back US taxpayers for the bailouts.
The recovery, and now expansion, in US housing has returned Fannie and Freddie to health again.
The question ever since has been what to do with them.
The US government to play the same card
for biggest voter demographic
Hardcore Republicans don’t like the US government having a big finger in the US housing pie. Some suggested that both Fannie and Freddie should be abolished completely.
Australia, for example, doesn’t have an equivalent institution, and the market gets along fairly well.
But politics keeps most of the US lawmakers favouring the continuation of Fannie Mae and Freddie Mac, and intertwined with the government.
Ultimately, it comes back to keeping voters happy.
US citizens are like Australians. They generally want to own a house (and they like to see it go up in value).
The American government can use Fannie and Freddie to help Americans onto the housing ladder.
The US home ownership rate is still historically low, and the millennial generation — which is entering its prime buying years — is the biggest demographic group in America.
Good politics and all that.
The Wall Street Journal reports that a plan is afoot to restructure Fannie and Freddie to keep them as central players in the US housing market.
Senator Mark Warner is quoted as saying,
‘We’re looking for a more simplified approach that protects the taxpayer, preserves the 30-year fixed mortgage and includes stronger access and affordability provisions.’
This is very important to see if this legislation passes. The language in The Wall Street Journal suggests that Fannie and Freddie’s mortgage bonds might, in the future, be completely backed by the US Treasury.
That will give these bonds massive appeal to investors because the risk gets passed across to the US taxpayer.
Note the ‘stronger access and affordability provisions’ line.
The US government is going to drop the tight standards in lending put in place since 2008, and heat up the US housing market again by letting in more buyers.
They can use Fannie and Freddie to do it.
Note that its real estate — and not the stock market — that undermines the wealth of the US consumer.
A hot housing market makes for a happy voter, and a willing consumer.
In May (which you can see here), I suggested that the then fear about the Fed winding down its QE program was overdone. My suggestion was that the US banks would expand just as the central bank retracted.
The gist was that US banks would expand as US real estate kept getting stronger, and demand for credit went with it.
This seems to be playing out. I suggested a US bank ETF back in August as a way to play this. It’s up about 14% since.
It suggests the market is pricing in growing earnings for the US banks.
Betting against the US economy in 2018 is not a bet I’d take.
Very few people pay attention to the obscure Freddie Mac and Fannie May businesses.
You and I can.
More loans are very bullish for middle America — and hence the world.
Editor, The Daily Reckoning Australia
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