Fannie, Freddie demand attention

Now that health care and financial reforms are in the works, it's time to shore up Fannie Mae and Freddie Mac.

By TheStreet Staff Mar 23, 2010 1:35PM

TheStreetBy Lauren Tara LaCapra, TheStreet

 

Now that other major agenda items are on the road to passage, the Obama administration has set its sights on the two big, gaping holes in America's balance sheet: Fannie Mae (FNM) and Freddie Mac (FRE).

 

Though the mortgage-finance giants stand to vaporize more taxpayer funds than any other bailed-out company, and are hugely important to economic policy goals, little has been said about Fannie and Freddie's future so far.


On Tuesday, Treasury Secretary Timothy Geithner spoke in broad terms about the plan to address Fannie and Freddie before the House Financial Services Committee. The plan appears to be for another hybrid public-private entity, but one whose government support is explicit, with risk priced more "appropriately" than it has been for decades.

 

"The housing finance system clearly cannot continue to operate as it has in the past," said Geithner, promising "stronger regulation, more effective consumer protections and a clearer role of government with less risk borne by the American taxpayer."

 

He also indicated that "guarantees or support" will be provided, but in a more explicit form than in the past. "There will be no ambiguity over the status or allowable activities of any private entity which enjoys any benefits or protections from the government."

 

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Rep. Barney Frank (D-Mass.), who chairs the committee, put the item on its agenda to push President Barack Obama's team to act. Frank is arguably the lawmaker most familiar with Fannie and Freddie -- and among those who pushed the firms into subprime -- but has been equally vague about what Fannie and Freddie ought to become, other than to say their current form ought to be abolished.

 

Sketching a definitive plan for Fannie and Freddie may not affect the stock market much, although their shares may become more volatile. However, it will affect mortgage rates, credit spreads, housing policy and bond markets.

 

The Bush administration is still widely criticized for mistakes in handling Fannie and Freddie, especially for rendering their preferred shares worthless when placing the firms into conservatorship. That created holes in the balance sheets of banks across the country. Regulators had advised them for years to hold those securities as safe, cash-like capital instruments.

 

The Obama administration has the advantage of taking the opposite tack: Patience and careful deliberation, rather than hasty decision-making. Postponing a decision has also allowed the government to use Fannie and Freddie as tools to repair the housing market and push banks into actions they might not otherwise take.

 

Because of their enormous scale, Fannie and Freddie have been able to send mortgage rates to historic lows, and prod banks to forestall foreclosures and modify mortgage terms. They have also been combing through vintage securities, forcing big banks like Bank of America (BAC), Citigroup (C) and JPMorgan Chase (JPM) to take back souring loans, whose shoddy underwriting standards were misrepresented.

 

"Private capital has not yet returned to provide the amount of funding that would be needed to allow families to get a mortgage to buy a new home or to sensibly refinance the house they already live in," Geithner said on Tuesday.

 

The policy initiative has been intended to support the mortgage market -- both homeowners and participating financial firms. Banks have made a killing on fees from the refinancing wave, and are arguably better off sharing housing losses with the government and borrowers, rather than facing additional years of default. Yet, after 18 months and nearly $130 billion worth of bailout funds to date, it's unlikely that new plans for Fannie and Freddie will be a gift to the financial industry, given the political climate and the Obama administration's goals.

 

Broadly speaking, there are three potential options.

 

Privatize Fannie and Freddie entirely, with no government guarantees or support for their activity, a policy that conservatives strongly support. They may also become some kind of nationalized entities that provide explicit support to the mortgage market, rather than implied guarantees in their current structure. This would allow the government to support home purchases for low-income, minority and other disadvantaged Americans, something liberals prefer. Finally, they may remain a quasi-public hybrid with explicit guarantees, which share risk and rewards with shareholders. This is the plan that the industry prefers.

 

On Tuesday, Geithner provided some indication of which way the government is leaning. But there's sure to be partisan bickering before any kind of bill reaches the floor of either chamber of Congress.

 

"We agree Fannie and Freddie should be replaced," Frank told the Wall Street Journal ahead of the hearing. "Until you've decided what to replace them with, it would be a mistake to abolish them.''

 

Related Articles

 

Citigroup seeks mortgage growth

 

Fannie, Freddie: financial winners & losers

 

Mortgage repurchase requests on the rise

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