In the US, 60% of the residential mortgage market is dependent on Government guarantees, though underwriting home loans is rather straightfoward as a banking product.
Government guarantees appear to be seen as panacea for all manner of economic and social problems. Taxpayers' promisses to pay work even better than current taxpayer funding. Politicians get to throw money around, but face no immediate resistance from voters.
What with bailouts of failing banks and companies and additional benefits and program commitments (entitlements), taxpayers are called upon to solve all problems and cover everyone's else mistakes. Additional calls on the taxpayers' money are also growing in the recesses of loss-making state-owned companies and in the form of contractual (availability) payments under PPP public service concession contracts that can go on for 30-40 years.
Like the Titanic, the taxpayers are sailing through ever more difficult waters, as the Government assume more and more fiscal risks.
The rating agencies, who have no capital at stake in their rating scores, may focus more on the actual Government debt than the liabilites hidden below the horizon.
But the financial markets have "sonar", and investors can evaluate and price even the indebtness that can't be seen.
Publication: The Economist, Saturday, September 26 2009
Guarantees offered during the crisis pose lasting risks to America
THE visible costs of the financial crisis are well known: bank recapitalisations, stimulus spending and shrunken tax revenues.Another set of liabilities—the guarantees thrown up around financial systems a year ago to quell panic and keep credit flowing—has received far less attention. Guarantees are popular because they entail no immediate cost. But they leave the sovereign balance-sheet exposed to lurches in the financial system’s fortunes.
In July the International Monetary Fund estimated that the median advanced economy had announced guarantee programmes worth 16.4% of GDP. The figure was 200% in Ireland, which guaranteed all its banks' liabilities, 50% in Britain and 34% in the Netherlands. The median bank recapitalisation was only 2.4% of GDP.
At first glance America is making progress withdrawing such guarantees. A backstop for money-market mutual funds expired on September 18th. A Federal Deposit Insurance Corporation ( FDIC ) guarantee for new bank debt is due to end in October. This week Bank of America said it would pay $425m to end a loss-sharing agreement with the federal government.
Yet America still has sizeable and, in places, growing contingent liabilities. The FDIC now guarantees $302 billion of bank debt, although it is unlikely to have to honour much, if any, of that since the lion's share was issued by big banks that the government is loth to let default. The bigger risk lies with a string of smaller bank failures, mostly caused by tumbling property values. After the FDIC repays depositors it tries to recoup the cost by selling the seized bank's assets. It now holds about $30 billion of assets from failed banks, and has agreed to share losses on a further $84 billion held by acquirers of the failed banks.
Reserves against future losses have eaten into the FDIC's deposit-insurance fund, leaving it at just $10 billion—less than one-fifth of its statutory minimum. Institutional Risk Analytics, a research firm, gloomily reckons that the FDIC's fund will take a total hit of $400 billion-500 billion before the crisis is over. The FDIC is now exploring options for replenishing the fund, including charging banks a special fee or asking them to prepay future fees. It could also borrow from the Treasury, or, less likely, from banks. Banks would ultimately have to cover all such costs through fees, but that would in turn reduce their ability to rebuild capital, potentially prolonging the need for government support.
But by far the most worrying contingent liability looming over America is its growing exposure to residential mortgages. Since 2008 the federal government has in effect backed the debt and guarantees of Fannie Mae and Freddie Mac, two huge housing-finance agencies. The Federal Housing Administration (FHA), another agency that will lend up to 97% of a property's value, has meanwhile been filling the vacuum left by subprime lenders. Total loans guaranteed by the three have grown by $277 billion this year, to $6.1 trillion.
By the end of the year the federal government will stand behind 59% of the mortgage market, says Edward Pinto, an industry consultant, more than double its exposure after similar interventions during the Depression (see chart). True, its share of the market was not much lower in 2003. But since then property values have tumbled and the average loan now stands at 90% of the home's value, up from 66% then. Mr Pinto predicts that the federal government will sustain $300 billion in credit losses on mortgage loans between now and 2012, and that the FHA will need a bailout. The agency dismisses such talk but concedes that its reserves are about to fall below its statutory minimum.
Apart from their direct costs, loan guarantees have other damaging effects. Michael Pomerleano, an economist who studied their use in the wake of the 1997-98 Asian crisis, says they lessen pressure on banks to dispose of bad assets. America's growing entanglement with the mortgage market also risks aggravating overinvestment in housing. The government should explain how it will withdraw its support before another crisis germinates.
Fonte: The Economist, various
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