Mortgage Anxieties Mean Limbo for Fannie and Freddie (Update1)
28 december 2009, by Dawn Kopecki (Bloomberg)
http://www.bloomberg.com/apps/news?pid=20601109&sid=aDo0bV8kOyNM&pos=12Dec. 28 (Bloomberg) -- Fannie Mae and Freddie Mac, the linchpins of the American housing market, continue to bedevil the U.S. financial system.
In February 2003, their regulator issued a report saying the companies were taking on too much risk by using implicit government backing to plunge deeper into the mortgage market.
The government-sponsored enterprises would pose a systemic threat to the economy in the “remote” chance that either failed, Armando Falcon told the Bond Market Association the same day. The Bush administration, considering his report a potential threat to financial markets, asked him to resign.
Five years later, regulators seized the mortgage-finance companies. Since then, leaders from former Federal Reserve Chairman Alan Greenspan to Warren Buffett have argued the companies can’t be sustained in their dual roles -- a for-profit enterprise beholden to shareholders and a tool of housing policy -- and should be nationalized or sold.
Nothing has happened. Instead, Fannie Mae and Freddie Mac, which buy home mortgages from banks and package them into bonds sold to investors, have been bailed out with $1.5 trillion in direct and indirect government aid. The Obama administration is banking on the companies to help end a three-year housing slump. The president is delaying plans to lay out a new framework for them in February, and Congress hasn’t scheduled hearings on their future.
‘Giant Pass’
“They’re going to get a giant pass on all of this,” said Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia who is now a bank analyst at FBR Capital Markets in Arlington, Virginia. It’s going to be “three to five years before their fate is determined.”
Rather than beginning to extricate itself from Fannie Mae and Freddie Mac as it is with other bailed-out businesses, the Treasury Department on Christmas Eve removed a $200 billion limit on aid to each of the companies and promised to cover their losses through 2012. Earlier, the Federal Reserve extended a mortgage-bond purchase program by three months, through March.
The approaching withdrawal of Fed support in the form of the mortgage-bond purchases risks “a very, very scary situation,” said Meredith Whitney, founder of Meredith Whitney Advisory Group LLC in New York. Mortgage rates would soar, endangering the economic recovery, if private buyers failed to step in to buy the companies’ debt, she said.
The status of Fannie Mae and Freddie Mac isn’t dealt with in the proposed overhaul of the financial regulatory system that the Senate plans to take up next year. While Treasury Secretary Timothy Geithner said in June that the companies’ future would be discussed in the president’s budget outline in February, the Treasury in its Dec. 24 statement promised only to provide a “preliminary report” by then.
Dual Mandates
Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac own or guarantee about $5.5 trillion of the $11.8 trillion in U.S. residential mortgage debt. They have financed as much as 75 percent of new U.S. mortgages this year.
They have been run for more than 40 years as shareholder- owned companies that also have a federally chartered mission to promote the housing market. Those dual mandates have collided and contributed to the companies’ failure, said Federal Deposit Insurance Corp. Chairman Sheila Bair.
“Go one way or the other,” Bair said in an interview this month. “Either completely privatize them and get them completely out or run them as public utilities.” The hybrid structure, with private shareholders, public mandates and federal backstopping, “is classic too big to fail.”
Mortgage Rates
The companies are helping carry out the Treasury Department’s $75 billion plan to let as many 9 million homeowners modify or refinance their loans to more affordable terms to curb foreclosures.
The Federal Reserve has bought $1.1 trillion of Fannie Mae and Freddie Mac’s home-loan bonds and $124.1 billion of their corporate debt this year. Those actions have lowered the companies’ funding costs and pushed mortgage rates to a record low 4.71 percent this month.
For the year, interest rates on typical 30-year fixed-rate mortgages have averaged 5.04 percent, down from 6.05 percent last year, according to weekly surveys by Freddie Mac.
To help keep the GSEs solvent, the Treasury has also bought $191 billion of Fannie Mae and Freddie Mac mortgage bonds, and made $112 billion of preferred stock purchases.
The companies have lost a combined $188.4 billion in the past nine quarters. The federal government now holds almost 80 percent of the equity in each of the entities.
Relaxed Timeline
Fannie Mae rose 17 cents, or 16 percent, to $1.22 at 10:25 a.m. in New York Stock Exchange composite trading. It has fallen about 83 percent since it was put in conservatorship in September 2008. Freddie Mac climbed 24 cents, or 19 percent, to $1.50 and has declined about 70 percent since it was seized.
The Treasury last week relaxed its timeline for Fannie Mae and Freddie Mac to shrink their portfolios of mortgage assets. Previously, the companies were instructed to do so at a rate of 10 percent a year. Now, they will be required to keep the value of their portfolios below a maximum limit, currently $900 billion, that will go down by 10 percent a year.
This means they won’t need to take immediate action to trim their holdings and could allow them to rise. Fannie Mae’s portfolio ended October at $771.5 billion and Freddie Mac’s holdings at the end of November were $761.8 billion, according to the latest figures released by the companies.
“Treasury does not expect Fannie Mae and Freddie Mac to be active buyers to increase the size of their retained mortgage portfolios, but neither is it expected that active selling will be necessary,” the Treasury said in the statement.
‘Asset Collapse’
The difference between yields on Fannie Mae’s 30-year fixed rate mortgage bonds and U.S. Treasuries narrowed to about 0.68 percentage point last month, the lowest since 1992, from close to a 25-year high at 2.32 percentage points just before the Fed announced its purchasing program. Yields on these and other so- called agency mortgage bonds generally guide interest rates on home loans.
The Fed has been “the only buyer in the market,” Whitney told Bloomberg Radio in a Nov. 19 interview. “If they pulled back from the market or stopped buying from the market, we think there’s an asset collapse here.”
Ajay Rajadhyaksha, a managing director at Barclays Capital in New York, says fears that Fannie Mae and Freddie Mac won’t be able to find buyers when the Fed halts its purchases of their corporate debt and mortgage bonds are overblown.
‘Cold Turkey’
“When you have someone as big as the Fed was in 2009 walking away cold turkey, there have to be bumps along the road,” Rajadhyaksha said in an interview. “But the thing to keep in mind is the massive amounts of cash that many investors have, which they absolutely want to put to work.”
Scott Buchta, the head of investment strategy at Guggenheim Securities LLC in Chicago, agreed, saying that the initial change will be “minimal.”
Yield spreads on Fannie Mae and Freddie Mac will rise 20 to 75 basis points, according to the strategists.
“That puts you at a mortgage rate of between 5.5 percent to 5.75 percent, which by historical standards is still not bad at all,” Rajadhyaksha said.
Test the Market
The FDIC’s Bair says the market needs to be tested, even if the price of some mortgage bonds falls.
“At some point you’re going to have to do it anyway, and if the market won’t support the values, and they have to go down, then well, that’s what the price should be and that’s how they should be valued,” Bair said. If the Fed is “gradual about it, I think they can ease out.”
Alabama Senator Richard Shelby, the ranking Republican on the Senate Banking Committee, said it’s a “grave mistake” to delay decisions about Fannie Mae and Freddie Mac’s future. “I fear that the longer we wait, the more it is going to cost the American taxpayer,” Shelby said at an Oct. 8 hearing.
Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, is putting Fannie Mae and Freddie Mac at the top of next year’s agenda, said Steven Adamske, a spokesman for the lawmaker.
“There is nothing on paper right now, but that day is coming,” Adamske said. “Their future is one of our next priorities next year.”
To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.com. Mortgage Anxieties Mean Limbo for Fannie and Freddie 28 December 2009 (Bloomberg)
http://tinyurl.com/y8wd389
