Sub-prime mortgages have been creeping back into the mainstream for months now, but a sympathetic article that appeared in The New York Times over the weekend presented them as a misunderstood tool that helps non-standard applicants get a mortgage. Rafferty Capital Markets VP of equity research Richard X. Bove sees this as confirmation that winding down Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and the creation of Qualified Mortgage rules will only move the risk somewhere else.

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Fannie Mae, Freddie Mac: Sub-prime MBS rebound “only a matter of time”

The NY Times article presents the slightly baffling case of Martin and Cindy Arroyo who are apparently unemployed, he’s just finished an MBA, and she has gone through a foreclosure, but they somehow have $550,000 cash to put down on a house. Without explaining how these seemingly contradictory details came together, the story explains that they weren’t able to secure a loan for the remaining 25% of the home they wanted to buy from banks, so they turned to a sub-prime mortgage lender.

At this point the volume of sub-prime mortgages “is not enough to bundle into securities for sale to investors,” writes Shaila Dewan in the NY Times. “But the lenders say it is only a matter of time before the market for subprime-mortgage-backed securities rebounds.”

Even if it’s true, as the article implies, that sub-prime or non-qualified mortgages are currently looking for high quality loans that don’t quite fit banks’ guidelines, expanding sub-prime mortgages almost necessarily means taking riskier loans. We all know that investors are starved for yield, so the push for more sub-prime mortgages with double digit interest rates isn’t surprising; finding out that their reputation can be so easily salvaged is.

Fannie Mae, Freddie Mac: Gov’t incented the recreation of sub-primes

“[Sub-prime] is now back as the Times reports. This is not good because after a few years it will collapse again if history and economics are any guide. Only this time, unlike the past, there will be no safety net for the failures,” writes Bove.“Not only has the government incented the recreation of the industry but it has laws in place to force it to fail when it becomes troubled in the next recession.”

Bove has consistently argued that government housing policy will push people out of traditional home financing and make it more expensive to buy a home. If all the new regulations meant to prevent another housing bubble simply send marginal loan applicants to non-traditional lenders with less oversight, then they haven’t really served their purpose.

Lax underwriting standards sub-prime MBS were responsible for tanking Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), even if the GSEs are being wound down, letting that risk ramp up elsewhere in the economy can’t end well.