On Christmas Eve, when the news was assured of getting no coverage whatsoever, The White House announced that it had eliminated the maximum bailout cap for Fannie Mae (FNM) and Freddie (FRE).
As some observers have pointed out, all the move really did was formalise what everyone has figured for decades, that the two zombie GSEs were truly organs of the federal government, and that their debts would be backed up ad infinitum.
So, why the move, and why then?
Credit analyst Edwart Pinto shares his theories.
What the Treasury’s lifting of the bailout caps on Fannie and Freddie might portend for 2010
Might Treasury be taking these steps in anticipation of the following?
1. Revisions to the flagging Homeowner Affordable Housing Program (HAMP). Any changes will likely increase near term bailout costs to Fannie and Freddie if HAMP’s current reliance on interest reduction is replaced in part by principal reduction. The losses associated with a modification of a loan using an interest rate reduction are spread out over time while a modification using principal reduction results in taking a more immediate loss.
2. Fannie and Freddie taking on a greater role in the near term to support their own mortgage backed securities (MBS). Now that the Treasury’s and the Federal Reserve’s own support programs are in the process of winding down, the administration’s actions may be preparing Fannie and Freddie as the vehicles for continuing this support. The Treasury’s December 24, 2009 announcement raises the portfolio limits to $900 billion each, thereby providing Fannie and Freddie with the ability on a combined basis to increase their portfolios by a total of $275 billion. At the current rate of the Fed’s MBS purchases, this new capacity would last about 4-5 months.
3. Fannie and Freddie growing their portfolios on a long term basis to provide continued support to the MBS market. Given the recent uptick in mortgage rates due to increasing Treasury rates, the lifting of the bailout caps may be designed to reassure investors in an effort to keep MBS spreads from widening relative to Treasury rates. By providing a more open ended capital commitment, along with the greater portfolio capacity now, Fannie and Freddie are in a position to grow their portfolios early in 2010. If the market accepts their purchases without wider spreads, then even higher portfolio dollar limits can be created with the stroke of a pen;
4. The administration’s announcement in February regarding the future role of Fannie and Freddie. In a separate press release also issued on December 24, 2009 it was revealed that the executive pay packages at Fannie and Freddie do not include a common stock component. This fact, along with the lifting of the bailout caps and the expanded portfolio capacity, may well indicate an intention to formalise Fannie and Freddie’s continued status as government agencies. If this were to happen, Fannie and Freddie’s outstanding common stock likely becomes worthless, making it of no use as an employee incentive. . This action would be justified by stating that Fannie and Freddie are just too important to the economic recovery to re-privatize.
5. Increasing the demand for Fannie and Freddie’s MBS by reducing the multiplier for bank risk based capital requirements from 20% to 10%. This action would help serve to keep spreads to treasuries narrow. Banks would only need 0.8% risk based capital to support their holdings of Fannie Freddie MBS versus the 1.6% needed today. The earlier noted lifting of Treasury’s capital support caps could provide the justification for this reduction in capital requirements, since it signals an increase in the government’s commitment to Fannie and Freddie..
The above actions would preserve and strengthen the government’s involvement and control over the country’s housing finance system and make it harder to reintroduce substantial private sector involvement later on. They would also continue distortions in the marketplace leading to who knows what unintended consequences. Finally these steps would do nothing to deleverage the housing finance system, a key step in returning it to any degree of normality.
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