Questions Surround Fannie, Freddie
By Nick Timiraos
The Wall Street Journal
December 30, 2009
The government's move to ease the limits on the securities holdings of Fannie Mae and Freddie Mac has ignited a debate among analysts about what the companies will do with their longer leash.
When the Treasury Department took over Fannie and Freddie last year, one of the requirements they set for the companies required them to begin shrinking their portfolios of mortgages and related investments, which total a combined $1.5 trillion. The idea was to rein in the companies' size and growth.
But last Thursday, the Treasury eased that requirement, meaning the companies won't be forced to sell mortgages next year into an already weak market and could even buy mortgages on the market, which could help hold down interest rates. The Treasury also suspended for the next three years the $400 billion cap on the bailout subsidy that the government will offer. That could give them more flexibility to modify mortgages without worrying about taking losses.
Mahesh Swaminathan, senior mortgage analyst at Credit Suisse, said the firms could use their increased capacity to purchase delinquent loans from pools of mortgage-backed securities that they guarantee. Fannie and Freddie already purchase defaulted loans as they modify them under the administration's loan-modification program, but the additional breathing room means it is now a "slam-dunk for them to speed up" purchases of delinquent loans, Mr. Swaminathan said. New accounting rules that take effect next year also could make it more cost-effective for the companies to buy out bad loans and keep them in their investment portfolios.
The relaxed portfolio limits calmed investor worries that Fannie and Freddie would be forced to sell some of their mortgage holdings just as the Federal Reserve was preparing to wind down its purchases of mortgage-backed securities next spring. The Fed's commitment to buy up to $1.25 trillion has helped to keep mortgage rates near record lows; without that support some economists have said that could rise to 6% by the end of 2010.
"The alternative would have been them selling into that market, which would have been even more difficult for the market to bear," Mr. Swaminathan said. Others said the new flexibility means that Fannie and Freddie could replace the Fed as a big buyer of mortgage-backed securities, especially if weak demand for mortgage-backed securities from private investors drives rates higher.
"It's created a government-purchasing facility other than the Fed," said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research firm in Washington.
A Freddie spokesman said the company has used and will continue to use its investment portfolio as "an important tool" to "keep order in the housing and housing-finance markets." A Fannie spokesman declined to comment.
A Treasury official said the more generous portfolio limits were offered to avoid forcing the companies to actively sell their holdings, and they didn't intend for Fannie and Freddie to be active buyers of mortgages. But some analysts said the government wouldn't object to Fannie and Freddie's presence in the market. "You're going to hope that because of their lower cost of capital they will be a bid in the marketplace," said Joshua Rosner, managing director of Graham Fisher & Co.
Ms. Petrou said that the recent moves "make sense in a short-term way because you avoid market volatility," but the prospect of limitless aid will make it harder to extricate Fannie and Freddie from the government.
"In a long-term way, it promotes nationalization of U.S. mortgage finance. We have increasingly gigantic, increasingly federal agencies eating up every mortgage out there," she said.
Although Fannie's and Freddie's core business is their role guaranteeing payments to mortgage investors, for years they earned additional profits and generated controversy by maintaining a large investment portfolio filled with mortgages and related securities.
The most controversial part of the Christmas Eve announcement was the decision to erase any caps on the amount of Treasury money that the firms can take. That gives the mortgage-finance companies and their government masters a much freer hand to respond to the housing crisis in the year ahead, possibly by moving more aggressively to modify troubled loans.
Some analysts said the companies now have greater flexibility to pursue more expensive loan modifications, including by writing down loan balances, which would have generated losses, requiring more government cash. But without a bailout ceiling, the administration "needs no longer worry that anything they do would drive Fannie or Freddie over the edge into negative net worth," said Ms. Petrou.
A Treasury representative said the bailout caps were suspended "specifically to ensure continued confidence in Fannie Mae and Freddie Mac, but were not based on any considerations" related to an expansion of the administration's loan-modification program.
The Treasury already has handed over about $112 billion to help shore up the companies, which were among the first big financial institutions to fall under government control in the wake of the nation's mortgage crisis. Fannie and Freddie are playing a crucial role in providing mortgage liquidity. They own or guarantee half of the nation's $11 trillion in home mortgages and together with the Federal Housing Administration are responsible for backing nearly nine in 10 mortgages.
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