UNCLE FRED AND AUNT FANNY ARE ON A COMEBACK: Old friends are taking advantage of the subprime mortgage market.
While mayhem in the residential mortgage market has spelled disaster for a handful of major players, Fannie Mae and Freddie Mac are hell-bent on making lemon-aide with the lemons all have been dealt.
Both government chartered firms were born with the dream of affordable housing. These close relatives have been helping lenders by purchasing their residential loans and recasting them as securities and ensuring the issuance of mortgage backed bonds to third parties. These power players maintain assets worth over $4 trillion. With this much lute in the pipes you would think they could afford a descent accountant. Old Aunt Fanny and Uncle Fred misreported earnings between 2001 and 2004 by over $11 billion. Mortgage company news. They were punished with more than a slap on the wrist; resulting in the loss of two top execs, healthy fines, portfolio caps, and increased capital requirements.
After a slew of legal Hail Maries, a few billion dollars in system revamps and a brigade of restatement teams, the couple is finally able to look industry company strait in the eye.
The two will reportedly have their books up to par as soon as this year; good news which has upped Auntie’s shares by 13%.
The Mister and Misses have been staging themselves as saviors of the downturn. The enchanted two have made an oath to buy up many billions of dollars worth of subprime loans. They are also preaching programs aimed at giving a crutch to the borrowers that suffered the most damage. Their good will has resulted in recent increases in their market share; a firm step towards redemption. A number of factors, including news of United Capital’s faulted hedge fund bets, have been pushing business to the old lady and her confidante.
Some are calling the pair out as being less the philanthropists and more the opportunists, suggesting that the duo is taking advantage of the tumultuous environment by filtering out less favorable lenders.
This may however been a slick move on the part of Mae and Mac, considering congresses current disdain for predatory lenders. The two may be putting on the yellow jersey sooner than we think. ARMs seem to be quickly loosing their charm in the face of safer more appetizing fixed rate options. Since the two remained reserved while others aggressively stuffed every deal in the market into their mouths, there is plenty of growing room in the pair’s portfolios. According to the Office of Federal Housing Enterprise Oversight’s director, this is a chance for them to lead by example in terms of proper underwriting.
A rep from Mac suggests that this is an opportunity for the two to advertise their power as market stabilizers. In fact, analysts have already surmised that the GSES’ price targets have been raised by the pair. The logic here being, the instability driven reduction in liquidity leads to higher spreads, and these higher spreads should allow the players to better satisfy their shareholders.
While Fannie Mae and Freddie Mac shy away from subprime lending, they have no fear of holding a substantial inventory of bonds associated with these loans. A significant portion of these deals are rated below AAA. In fact, a 15-30% of these sub AAA deals could result in losses of over $3 billion for Mae and Mac. A hit like this would buffer them down to baseline.
The thought that the GSES poses a threat sends shivers down the spines of the Treasury folk. Not only are they giants, but they are backed by the big hand of the Fed. Uncle Sam guarantees that they can borrow at rates similar to those on no-risk Treasury bonds, with no caveats regarding their financial situation. This allows for dangerous growth spurts; between 1990 and 2005 their portfolios grew by tenfold while the GDP barely doubled.
In cases of default, the American people would foot the bill. Since there are no limits on how much of Mae and Mac’s debt banks can hold they would take a hit as well. It is common for banks to hold more GSE paper than regulatory capital. This leaves potential for disastrous ramifications if Miss Mae or Mr. Mac were to fold.
As we all know, there is no guarantee when it comes to stability. In light of this, the Treasury and OFHEO are pushing Congress to pass a bill giving more power to the current regulator. Still, the GSES appear to be unshaken by the idea of stricter regulation. Get Mortgage leads.
Their worry department is probably preoccupied with other sources of competition such as covered bonds and home-loan securitization trusts. Permanence is often transient. Paired with the highly liquid secondary market, Auntie Mae and Uncle Mac will be in competition with commercial banks when times are good.
This was a review of “Fannie and Freddie Ride Again” originally printed in The Economist, July 7th 2007, page 71-72.
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