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Strategies & Market Trends : Freddie Mac (FRE) pops the housing bubble

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From: mlkr9/16/2009 10:09:48 PM
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By Lynn Adler

NEW YORK, Sept 10 (Reuters) - The government's seizure and support of home funding companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N) a year ago will likely muddy efforts to restructure the companies, according to a Government Accountability Office study.

Tasking Fannie Mae and Freddie Mac with limiting the scope of the housing crisis "may be necessary," the GAO said, but it may also "significantly affect the costs of the conservatorship and transition to a new structure."

Since the takeover, which the Congressional Budget Office estimated will cost taxpayers nearly $400 billion, the government has relied heavily on both companies to revive U.S. housing, the bane of the economy during a deep real estate slumpthat began more than three years ago.

As part of the conservatorship, the companies can increase their mortgage investment portfolios to help restore housing market stability before having to start cutting the holdings in 2010.

But the government had to come to the rescue of the two finance companies who had more than $5 trillion in outstanding obligations by pumping tens of billions of dollars in capital into Fannie and Freddie through stock purchases among other financial supports. As of June 30, the Treasury had provided about $85 billion to the GSEs.

"Investors might be unwilling to invest capital in reconstituted enterprises unless Treasury assumed responsibility for losses incurred during their conservatorship," the report said.

The GAO said the two companies have a mixed record in meeting their housing mission objections and both capital and risk management problems compromised their safety and soundness.

The GAO said its study, released on Thursday, was prepared with broad input from regulators and the entities, to guide Congress in its debate about the fate of Fannie and Freddie.


The two companies are structured as government agencies owned by shareholders, but investors grew to rely on expectations that the government would bail out Fannie Mae and Freddie Mac debt in a crisis.

Although the debt did not carry an "explicit guarantee", the U.S. a year ago did intervene and commit to backing the finance companies via company stock and debt purchases. This only reinforced the market's perception of a government guarantee that may be hard to sever.

The debt of both companies has rallied through the last year, pushing risk premiums down from record highs versus Treasuries during the worst of the markets meltdown in the past year to record lows.

"While the enterprises are now a critical component of the federal government's response to the housing crisis, such support would not be possible without Treasury's financial support and the Federal Reserve's plans to purchase almost $1.45 trillion of their MBS and debt obligations as well as those of other entities," GAO said in the study.

The U.S. Federal Reserve has set a goal to buy up to $1.25 trillion of agency MBS and $200 billion of agency debt before the end of this year to help lower home loan borrowing costs.

The Fed purchases of agency MBS total $836.5 billion so far in 2009 while the Fed's purchases of agency debt totals $122.366 billion.

Fannie Mae, through spokesman Brian Faith, declined to comment on the GAO report.

Sharon McHale, Freddie Mac spokeswoman, was not immediately available to comment.


The main options Congress will consider, with some overlap, are as follows:

-- Reconstitute the GSEs as for-profit corporations with government sponsorship but add restrictions to control risks. This could eliminate or reduce portfolios, establish executive compensation limits, or convert GSEs from shareholder-owned corporations to associations owned by lenders.

-- Create government corporations or agencies. The entities would focus on buying qualifying mortgages and issuing mortgage-backed securities but eliminate portfolios. The Federal Housing Administration, which insures mortgages for low-income and first-time borrowers, could assume more responsibility for promoting homeownership for targeted groups.

-- Privatize or terminate Fannie Mae and Freddie Mac. This would disperse mortgage lending and risk management through the private sector. Some proposals involve establishing a federal mortgage insurer to help protect lenders against catastrophic mortgage losses.

Each option has its trade-offs. All would need probably need a transition period to mitigate market disruption and ease the development of a new mortgage finance system, GAO said.

See the report here

See also a scenarios factbox on likely options for Fannie and Freddie in the future [ID:nN10402864]
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