Submarined in an "update" on the "status" of Fannie Mae (FNM) and Freddie Mac (FRE), the White House quietly announced on Christmas Eve that, instead of just pumping in hundreds of billions of dollars, its support for the GSEs' damaged Hindenburg-sized balance sheets would be unlimited for the next three years.
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But what is behind this drastic move to uncap the Treasury's credit pipeline for Fannie and Freddie, since the two have been in full implosion mode for a year and a half?
Is the government quietly planning to force these two invalids, permanently stuck in the government's emergency room, to take on even more rotting mortgage loans?
That would present a sea-change in policy, even though it's in the bylaws of Fannie and Freddie to take on sour loans. Fannie and Freddie were placed into conservatorship in the early fall of 2008 and are now hostage to the government's every crisis move.
The dramatic shift would come as the Obama administration is putting off any effort at reforming Fannie and Freddie, and at a time when pay czar Ken Feinberg has no jurisdiction over the two companies, both of which just agreed to pay their top executives up to $6 million in compensation for 2009.
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If the government moves to open up the Fannie and Freddie floodgates even more, it would push the poisonous swamp of moral hazard beyond the tipping point. It would show it's willing and able to not just explicitly back the biggest bailouts in the history of the country, but also continue to give support to the worst, most irresponsible crop of borrowers taxpayers have ever endured.
Already, Fannie and Freddie hold or insure about 10 million subprime and Alt-A loans, as well as mortgage-backed securities, worth in total about $1.6 trillion. This stew of loans and debt is seeing record delinquencies.
The government-dependent enterprises have already cost taxpayers $110 billion in losses, they've already drawn down $111 billion from the Treasury, and both admit in SEC filings that they will continue to bleed money for some time to come in order to prop up the Administration's effort to revivify the U.S. economy by supporting home buying.
But, Why Now?
It's more than just rising home delinquencies. Fannie Mae just reportedthat the rate of serious delinquencies - those at least three months behind - on conventional loans in its single-family guarantee business rose to 4.98% in October, up from 4.72% in September - and about triple the 1.89% rate in October 2008.
It's about bombed-out bank balance sheets. The banks are desperately struggling to raise capital, as their cushions remain wafer thin.
Meanwhile, the U.S. must roll over $2.5 trillion in debt in the next two years, banks worldwide have $7 trillion in corporate bonds due in the same time span and $750 billion in commercial real estate loans are coming due, too, says Stephanie Pomboy of MacroMavens, as quoted in Alan Abelson's column in Barron's.
Of course, the loan securitization market is dead in the water, with securitizations off by 90%, depending on the day. That means banks can no longer offload new loans via securitization and are stuck with the soggy stuff on their balance sheets.
The Federal Reserve is now the mortgage securitization market, as it now has $910.3 billion in mortgage-backed securities on its balance sheet, out of a planned $1.25 trillion in such purchases. But it can only tread water for so long. And that Fed program is set to expire next March, which means Fannie and Freddie will need an assist once that happens.
At the same time, U.S. accounting rule makers are forcing the banks to take back onto their balance sheet securitizations and all sorts of other assets now warehoused in off-balance- sheet conduits. Barclays reckons the rule will force roughly $500 billion in off-balance- sheet assets back onto bank balance sheets in 2010, requiring even more capital raises.
Fannie and Freddie would have to pull back onto their balance sheets off-balance sheet assets, so buying back loans may help them more quickly strip down securitizations.
The government's expanded capital backstops and portfolio limits for Fannie and Freddie increase “the prospect of large-scale” purchases by the companies of delinquent mortgages out of the securities they guarantee, Mahesh Swaminathan and Qumber Hassan, Credit Suisse debt analysts in New York, wrote in a report.
The two added: “This announcement increases the prospect of large-scale voluntary buyouts by removing the portfolio cap hurdle and helping funding by potentially increasing debt-investor confidence.” JPMorgan Chase is also betting on Fannie and Freddie buying out loans that back their securities in 2010. Bloomberg broke this story within the past week.
One of the best business blogs out there, Calculated Risk, quotes former columnist Doris “Tanta” Dungey as raising this possibility a few years ago. Dungey was the most influential, gifted writer on the mortgage derivatives meltdown, and has since passed away — a terrible loss for the financial markets, as her voice has never been more needed than now:
"Fannie Mae has always had the option to repurchase seriously delinquent loans out of its MBS at par (100% of the unpaid principal balance) plus accrued interest to the payoff date. This returns principal to the investors, so they are made whole. If Fannie Mae can work with the servicer to cure these loans, they become performing loans in Fannie Mae's portfolio. If they cannot be cured, they are foreclosed, and Fannie Mae shows the charge-off and foreclosure expense on its portfolio's books (these are no longer on the MBS's books, since the loan was bought out of the MBS pool).
"Now, Fannie also sometimes has the obligation to buy loans out of an MBS pool. But we are ... talking about optional repurchases. Why would Fannie Mae buy nonperforming loans it doesn't have to buy? Because it has agreed to workout efforts on these loans, including but not necessarily limited to pursuing a modification.Under Fannie Mae MBS rules, worked-out loans have to be removed from the pools (and the MBS has to receive par for them, even if their market value is much less than that)." [Calculated Risk's emphasis]