Don't Celebrate Real Estate's Recovery Yet

I wish I felt like joining the party that sent the Dow Jones Industrial Average up nearly 300 points on Monday on news of the Treasury plan to put mortgage giants Fannie Mae and Freddie Mac into a "conservatorship."

Not that I disagree with Treasury Secretary Henry Paulson's approach. People can and will argue about the details, such as whether the huge government-sponsored mortgage companies should have been put into receivership, wiping out shareholders, rather than being allowed to linger on as New York Stock Exchange-traded companies trading like penny stocks. But the important thing is that decisive action was taken.

Still, this is good news only by contrast to letting the companies flounder and setting off a global financial crisis. The best news would surely have been Paulson's Plan A, which would have required no action beyond his earlier guarantees of the companies' debt and a vague pledge to supply further capital if needed. Under that rosy scenario, mortgage markets would have stabilized by now along with confidence in Fannie and Freddie, and the two companies could have raised more capital on their own. Unfortunately, the reality was that home prices continued to plummet and mortgage defaults keep soaring, further eroding the value of mortgage-backed securities and dooming Fannie and Freddie.

Paulson said the companies will no longer be managed as though they had a fiduciary duty to shareholders. So in whose interests will they be managed? Those of the taxpayers, who are on the hook for billions in losses? Those of the banks and the global banking system, who need Fannie and Freddie to keep buying mortgage securities? Those of realtors and home builders, who want the companies to prop up real estate values? Those of affordable-housing advocates, who want easier lending and underwriting policies so more people can own their own homes? Some vague sense of the public interest?

Unfortunately the answer cannot be all of the above, since too many of these interests are in conflict. Indeed, trying to serve all these masters is what got Fannie and Freddie into this huge mess. It's a fiction that Fannie and Freddie ever were managed with a fiduciary duty to shareholders, as anyone unlucky enough to own their shares surely now realizes. I don't envy whoever has to sort out this mess.

In their heydays, Fannie and Freddie certainly helped prop up home prices. Surely on that score none of their allies in Congress can complain. They were part and parcel of a system that fueled a real estate bubble of historic proportions. The result was millions of people who bought houses for more than they were worth and at prices they couldn't afford. Where's the public benefit in that?

A legitimate cause for celebration will be signs that the nation's housing market has hit bottom and begun to recover. Mortgage default rates are going to keep rising as long as people are being asked to make payments on mortgages that are greater than the values of their homes. Are there any glimmers of hope? The National Association of Realtors announced on Tuesday that pending home sales dropped again in July, dashing expectations of a continuing rebound after positive results in June. And prices of existing homes fell 7.1% in July. The only good news there is that the faster prices fall, the sooner they will hit bottom, at which point we'll at least know the extent of the disaster.

An Investment Opportunity?

Now that the government has made even more explicit its guarantee of Fannie's and Freddie's bonds (as opposed to their common and preferred stock), shares of mortgage REIT Annaly Capital Management (NLY) may be attractive for yield-hungry, risk-tolerant investors. Annaly has a big position in Freddie and Fannie Bonds. For details, see Igor Greenwald's column of July 18. Annaly shares rallied this week, but still yield more than 13%. Any yield that high entails risk, including the fact that Annaly uses leverage to boost returns. Despite my heretofore money-losing forays into mortgage REITS, I recently bought some shares.