The Takeover of Fannie Mae and Freddie Mac
Yesterday, we saw the other shoe drop in the current mortgage crisis as the Federal Government took control of the Federal National Mortgage Association, "Fannie Mae", and the Federal Home Loan Mortgage Corporation, "Freddie Mac". These two big firms, which we have discussed before, were not in imminent danger of collapse, but their financial condition has continued to deteriorate since Congress' enactment of regulatory legislation in late July. Investors saw the new regulatory powers as beneficial, but without knowing exactly what form the Government's intervention would take, they weren't any more willing than before to buy the companies' bonds.
So now we know.
The Backstory: Mortgage Rates Still High
To recap the backstory briefly: Fannie Mae and Freddie Mac buy mortgage loans from banks and mortgage companies and, through the wonder of modern computer technology, they package groups of loans together into "pools" and sell them to investors worldwide. The instruments are called "pass-through" securities, since the borrowers' monthly payments of principal and interest are passed through to the ultimate bondholders. About half of all home mortgages outstanding have been handled this way, and that share has increased during the last year as some independent mortgage lenders have pulled back.
What happens to Fannie Mae and Freddie Mac matters to us as homeowners and would-be homeowners. If those mortgage-backed pass-through bonds can be sold easily because investors have confidence in the process, then the interest rate you and I pay on our mortgage loans can be lower.
As it is, such confidence has been lacking. Investors have taken the bonds only with notable premium rates. Consequently, despite the Federal Reserve's cuts over the last year in its key policy target rate from 5.25% to 2.00%, that is, by 3.25%, rates on standard 30-year fixed-rate mortgages have fallen a mere 0.11%. In fact, mortgage rates have risen since January, from a low of 5.48% to 6.35% last week. Thus, virtually none of the Fed's monetary policy easing has found its way into mortgage rates, a sorry end, since that was one of the main factors driving the policy action.
Conservatorship
What is the Government doing? The Treasury and the main mortgage industry regulator, the new Federal Housing Finance Agency, have taken management control of Fan and Fred in an arrangement called "conservatorship". Technically, the government did not assume ownership, but in stock trading today, the prices of both companies' common stock are about 75 cents/share, down almost 90% from Friday's already drastically reduced amounts.
The companies, which already have new CEOs effective yesterday, will continue to operate more or less normally, but now have strict limits on the volume of business they can do. "Growth" and "risk-taking" are no longer part of their strategies. The firms have as their only objectives the regaining of their own financial footing and of investor confidence. The nominal goal of the Federal Government is to provide an environment where this can happen with eventual return of the companies to private control. Whether this actually occurs or not remains to be seen, but it strikes us as a constructive beginning. Already, the firms' direct debt (their own bonds, not the pass-throughs) has improved today, with the premium over Treasuries down by some 0.35%.
Treasury Investments: Costs – and Benefits
The Treasury will invest as needed in a special class of preferred stock to shore up the firms' capital. It will also purchase for itself some of the mortgage backed pass-throughs. So we taxpayers are definitely on the hook here, and right now, there are no concrete estimates of the amounts these actions might ultimately cost us. At the same time, since the government will own some financial assets, to the extent that those generate income, there will be some returns. And since the Treasury will augment market demand for the mortgage-backed bonds, there is the clear benefit to those of us who buy homes in the prospect for lower mortgage rates, and thence to those who build and furnish those homes. A boost to the economy and more tax receipts could result.
Foreign Investors
There's another group of interested parties here. Foreign central banks own substantial amounts of the straight bonds of Fan and Fred, and other foreign investors own quantities of their mortgage-backed securities. We noted here in late July that the central banks had increased their holdings at the time Congress was acting on the enabling legislation. But this soon reversed, according to weekly data published by the Federal Reserve; over the last seven weeks, these banks have been net sellers of $18 billion worth of the debt. A large commercial bank in China lately announced that it had reduced its portfolio of Fan's and Fred's bonds by 25% just since June 30, some $4.5 billion worth. So the Federal Government has a role in conducting international financial policy affairs, especially in the run-up to a Presidential election, when investors everywhere might be concerned about the status of Government-related institutions. [Both Presidential candidates were briefed on the takeover by Treasury Secretary Paulson prior to Sunday's announcement.]
Moral Hazard: Opening A Can of Worms?
Finally, what about moral hazard, the topic of our article on July 28? Are we setting a precedent that only leads to more and more calls on Government support? How will that play out? Already, we see activity in the auto industry, for instance. Nominally there's a good reason for government intervention here too, utilizing government-guaranteed debt to finance retooling of plants to build more fuel-efficient cars, as required by a law passed last December. But press coverage today indicates that the companies believe the $25 billion of these guarantees authorized then won't be enough – they'll need $50 billion, some now say. This resembles some investor comments about the Fannie Mae and Freddie Mac plan. During the Treasury's preparations in August, some investors were surveyed about specific amounts of intervention; whatever number the Treasury proposed in its survey, the investors wanted more. If Treasury said $20 billion, they said $30 billion would be better. But the Treasury proposed $30 billion to another group, who said, oh we'll really need $40 billion. The Government is still tiptoeing through a minefield, isn't it? Nobody said this would be easy . . . .
So now we know.
The Backstory: Mortgage Rates Still High
To recap the backstory briefly: Fannie Mae and Freddie Mac buy mortgage loans from banks and mortgage companies and, through the wonder of modern computer technology, they package groups of loans together into "pools" and sell them to investors worldwide. The instruments are called "pass-through" securities, since the borrowers' monthly payments of principal and interest are passed through to the ultimate bondholders. About half of all home mortgages outstanding have been handled this way, and that share has increased during the last year as some independent mortgage lenders have pulled back.
What happens to Fannie Mae and Freddie Mac matters to us as homeowners and would-be homeowners. If those mortgage-backed pass-through bonds can be sold easily because investors have confidence in the process, then the interest rate you and I pay on our mortgage loans can be lower.
As it is, such confidence has been lacking. Investors have taken the bonds only with notable premium rates. Consequently, despite the Federal Reserve's cuts over the last year in its key policy target rate from 5.25% to 2.00%, that is, by 3.25%, rates on standard 30-year fixed-rate mortgages have fallen a mere 0.11%. In fact, mortgage rates have risen since January, from a low of 5.48% to 6.35% last week. Thus, virtually none of the Fed's monetary policy easing has found its way into mortgage rates, a sorry end, since that was one of the main factors driving the policy action.
Conservatorship
What is the Government doing? The Treasury and the main mortgage industry regulator, the new Federal Housing Finance Agency, have taken management control of Fan and Fred in an arrangement called "conservatorship". Technically, the government did not assume ownership, but in stock trading today, the prices of both companies' common stock are about 75 cents/share, down almost 90% from Friday's already drastically reduced amounts.
The companies, which already have new CEOs effective yesterday, will continue to operate more or less normally, but now have strict limits on the volume of business they can do. "Growth" and "risk-taking" are no longer part of their strategies. The firms have as their only objectives the regaining of their own financial footing and of investor confidence. The nominal goal of the Federal Government is to provide an environment where this can happen with eventual return of the companies to private control. Whether this actually occurs or not remains to be seen, but it strikes us as a constructive beginning. Already, the firms' direct debt (their own bonds, not the pass-throughs) has improved today, with the premium over Treasuries down by some 0.35%.
Treasury Investments: Costs – and Benefits
The Treasury will invest as needed in a special class of preferred stock to shore up the firms' capital. It will also purchase for itself some of the mortgage backed pass-throughs. So we taxpayers are definitely on the hook here, and right now, there are no concrete estimates of the amounts these actions might ultimately cost us. At the same time, since the government will own some financial assets, to the extent that those generate income, there will be some returns. And since the Treasury will augment market demand for the mortgage-backed bonds, there is the clear benefit to those of us who buy homes in the prospect for lower mortgage rates, and thence to those who build and furnish those homes. A boost to the economy and more tax receipts could result.
Foreign Investors
There's another group of interested parties here. Foreign central banks own substantial amounts of the straight bonds of Fan and Fred, and other foreign investors own quantities of their mortgage-backed securities. We noted here in late July that the central banks had increased their holdings at the time Congress was acting on the enabling legislation. But this soon reversed, according to weekly data published by the Federal Reserve; over the last seven weeks, these banks have been net sellers of $18 billion worth of the debt. A large commercial bank in China lately announced that it had reduced its portfolio of Fan's and Fred's bonds by 25% just since June 30, some $4.5 billion worth. So the Federal Government has a role in conducting international financial policy affairs, especially in the run-up to a Presidential election, when investors everywhere might be concerned about the status of Government-related institutions. [Both Presidential candidates were briefed on the takeover by Treasury Secretary Paulson prior to Sunday's announcement.]
Moral Hazard: Opening A Can of Worms?
Finally, what about moral hazard, the topic of our article on July 28? Are we setting a precedent that only leads to more and more calls on Government support? How will that play out? Already, we see activity in the auto industry, for instance. Nominally there's a good reason for government intervention here too, utilizing government-guaranteed debt to finance retooling of plants to build more fuel-efficient cars, as required by a law passed last December. But press coverage today indicates that the companies believe the $25 billion of these guarantees authorized then won't be enough – they'll need $50 billion, some now say. This resembles some investor comments about the Fannie Mae and Freddie Mac plan. During the Treasury's preparations in August, some investors were surveyed about specific amounts of intervention; whatever number the Treasury proposed in its survey, the investors wanted more. If Treasury said $20 billion, they said $30 billion would be better. But the Treasury proposed $30 billion to another group, who said, oh we'll really need $40 billion. The Government is still tiptoeing through a minefield, isn't it? Nobody said this would be easy . . . .
posted by Carol S. | 9/08/2008 06:09:00 PM
1 Comments:
Thanks so much for this. This does strike me as a hopeful event, and I hope it makes lots of people invest. But I do wonder where it ends, since other industries are also important. Maybe this is the start of a widespread entry of government into these situations.
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