The Government Will Ruin QE3
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In an unexpected twist of irony, the Government has become its own worst enemy. The Fed recently launched its $40 billion per month mortgage bond buying program, QE3, to keep mortgage rates low for those hoping to borrow to finance homes.
Part of the plan has worked – 30-year mortgage rates have touched the 3.5% area, an incredibly low level. However, the implementation of the Fed’s plan left a bit to be desired. Here is why.
Put-Backs Ruining Lending
Government-run Fannie Mae and Freddie Mac (NYSE: FRE-PK) look to be stifling lending among banks, not stimulating it. The two enormous mortgage firms buy loans from lenders and banks that meet certain standards, and they back 90% of loans made today.
The trouble is that the companies have enacted a policy called the “put-back,” which forces banks to take back the loans the banks originated before selling to Fannie and Freddie. Unfortunately, some of those loans have already gone bust, so the government organizations are essentially forcing public banks to take losses in their stead.
The Wall Street Journal reported that the two firms have asked banks to “repurchase $66 billion in mortgages made between 2006 and 2008.” According to the Wall Street Journal, one bank originated a loan in 2003, and the borrower defaulted in 2010. Earlier this year, Fannie Mae demanded that the bank repurchase the mortgage. Thus, the government’s actions have far-reaching consequences.
Who it Affects
Fannie and Freddie’s policies affect banks like Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC).
Bank of America has been scrutinized by the two firms, despite the fact that some of the company’s originated loans have longer histories of payments. Bank of America says that at the end of June, $8 billion of its put-back claims “were for loans on which borrowers had made at least 25 payments. That compares with just $3.7 billion in such loans at the end of last year.”
Of course this puts Bank of America’s earnings in flux. The bank does not know for certain when or how many bad loans will be put-back to it. As tensions grew, Bank of America simply stopped selling loans to Fannie and Freddie.
Citigroup also faces tensions. Citigroup paid a large fine for knowingly falsifying mortgage loans sold to Fannie and Freddie. Also, the company set aside $1.2 billion last year to take in bad loans that it sold to Fannie and Freddie. Like Bank of America, Citigroup could have loans put-back to it at any time, forcing the bank to incur losses. Of course this makes Citigroup stock a much riskier play.
Finally, Wells Fargo (NYSE: WFC) bumped up its put-back fund last year from $1.2 billion to $1.3 billion, showing the uncertainty banks face from Freddie and Fannie. And Wells Fargo just can’t seem to win with the Government. The Federal Housing Administration announced that it is suing Wells Fargo for hundreds of millions of dollars. The FHA backs loans made by banks that meet its standards, but the FHA is accusing Wells Fargo of making bad loans all the way back to 2001. The implications of the suit on Wells Fargo’s earnings are not clear, but they will be detrimental to the share price.
Mixed Messages
Personally, the uncertainty with banks has turned me sour on the sector. I am not long any financial securities because of the uncertainty facing their earnings – not that earnings matter anyway – and I do not plan to initiate any positions unless the market drops.
It is reasonable for Fannie and Freddie to look for ways to make the big banks pay, but now the banks will be even tighter with lending. To me, it looks like the Government is giving mixed signals. The Fed wants the banks to lend – but Fannie and Freddie are making lending harder. Goodbye, QE3.
Look Further
To learn more about the most-talked-about bank out there, check out the Fool’s in-depth company report on Bank of America. The report details Bank of America’s prospects, including three reasons to buy and three reasons to sell. Just click here to get access.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
