New housing legislation and the Fannie Mae / Freddie Mac bailout

Not surprisingly, Congress is likely to pass legislation this week which will make a limited financial commitment to the government - sponsored mortgage giants and attempt to restart the housing markets. This avoids the unpleasant alternative of guaranteeing the mortgage giants' debt, which would dramatically increase the federal government's overall debt.

The legislation will expand the government's authority over the government sponsored enterprises, particularly their minimim capital requirements (which you can expect them to use), which means pretty much that Fannie and Freddie are likely to be slow growers in the future, as they will be forced to build up their capital and stop buying as many loans. My guess is that, if this legislation proves effective at stabilizing demand for mortgage-backed securities, you'll see it applied to the rest of the financial sector. Generally, I think that banking is likely to be over-regulated over the next few years, meaning a slow growth environment for the financial sector. That having been said, it should survive. Historically, banks were slow-growing, unremarkable, but reliable investments. I think you'll likely see that trend be encourgaged by regulators for some time to come.

Congress will also likely pass legislation allowing the FHA to buy mortgages from distressed borrowers at a 15% discount. Essentially the effort seems to cover institutions that expect that the entire subprime slice is going to default on their mortgages. This will, at least, remove the most skittish debt owners from the market. Certainly pricing on the individual mortgages that I have seen has improved dramatically in the last few weeks and morgage backed securities as a class have started to improve.

As far as mortgage rates are concerned, I suspect that they will trend upward over time, but remain fairly low by historic standards. That having been said, its reasonable to expect that financing will require 25% of the purchase price and the borrowers will need to demonstrate that they will find the cost of the mortgage very easy to handle on their incomes.