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Fannie and Freddie Blowing Up Another Bubble

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The usual suspects are in the process of inflating an eerily familiar bubble.

It’s another housing bubble, but this time centered on rental property.

This is just one of many bubbles floating out there across the economic landscape. We have reported extensively on the stock market bubble, the student loan bubble, the debt bubble, and the auto bubble. We even told you about a shoe bubble. The air in these balloons all blows in from the same place – government and central bank policy. Artificially low interest rates, stimulus spending, and government policy combine to inflate asset bubbles. At their core, they are nothing but unnatural economic distortions.

And of course, at some point, they pop.

The rental bubble is particularly disturbing because it bears so much similarity to the housing crisis that crashed the economy in 2008. It even features some of the same lead characters – Fannie Mae and Freddie Mac.

According to data compiled by Wolf Street, the apartment building boom in the US will set a record in 2017. Analysts estimate 346,000 new rental apartments in buildings with 50+ will hit the market this year. This follows record-setting year in 2016. And a record-setting year in 2015.

Las Vegas alone will get 5,000 new apartment units this year. That seems pretty significant until you consider that New York and Dallas, will add 27,000 and 25,000 units, respectively. Chicago will add 7,800 units despite a shrinking population and rents decreasing 19%.

So, how do Freddie and Fannie fit into the story line?

In a recent press release, Fannie Mae bragged, “Fannie Mae (FNMA/OTC) provided $55.3 billion in financing and supported 724,000 units of multifamily housing in 2016 – the highest volume in the history of its Delegated Underwriting and Servicing (DUS®) program.”

Douglas French with the Mises Institute shines a little more light on the issue.

Fannie and Freddie made 53% of all apartment loans in 2016, that’s down from their combined 68% market share in 2012. So, their conservator, The Federal Housing Finance Agency (FHFA), recently eased the GSE’s lending caps so they can crank out, even more, loans.”

Sound familiar? Remember when government officials decided every American should own a home and started lending out money to pretty much anybody who could scrawl their signature on a mortgage form? Remember Freddie and Fannie helping facilitate the policy? It’s kind of like that. Except this time it’s commercial projects peddling rental homes in multifamily buildings.

Here’s something else that will sound familiar courtesy of Wolf Richter.

Government sponsored enterprises (GSEs) such as Fannie Mae guarantee commercial mortgages on apartment buildings and package them in Commercial Mortgage-Backed Securities. So taxpayers are on the hook. Banks are on the hook too.”

What could go wrong, right?

Once again, easy money has created a “build them and they will come mentality.” Prices skyrocketed and rents pushed upward, fueling more speculation. But signs of trouble have appeared on the horizon. Richter writes:

The prices of apartment buildings nationally, after seven dizzying boom years, peaked last summer and have declined 3% since. Transaction volume of apartment buildings has plunged. And asking rents, the crux because they pay for the whole construct, have now flattened.”

Uh oh.

Way back in 2002, Robert Blumen wrote a paper warning Fannie Mae Distorts markets.

GSEs [government sponsored enterprises] are not a free-market intermediary. Unlike private transactions in which the risk is shared by agreement among the parties to the transaction, GSEs silently transfer default risk (beyond their own meager capital reserves) to the taxpayer through an implied government guarantee. But that’s not all. For other reasons, agency debt is more attractive than debt issued by private corporations. Because it has transferred some of the default risk to third parties, Fannie is less cautious in evaluating the default risk of borrowers than a private firm risking its own capital would be. Another factor is that GSE securities are accorded preferential treatment in the calculation of bank reserves, so they can be purchased in many cases where private MBS or other forms of debt could not. And finally, the GSEs themselves are exempt from federal and state income taxes … Fannie’s monopoly privileges have given it an ever-increasing share of the secondary conforming mortgage market, and it currently is seeking to expand into other parts of the mortgage market.”

And here we are 15 years later.

Economic central planners never learn their lessons. They repeat the same thing over and over, convinced a tweak here and there will make it work this time around. It never does.

The rental bubble will pop just like the housing bubble did in 2008. Will it bring the economy down with it? Maybe not. But don’t forget, the commercial real estate bubble is just one of many balloons floating around out there. French offers a poignant warning we’d do well to consider.

As usual, cheap money entices developers to over do it, and the fall will be just as painful.”


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