September 08, 2008
Managing the $6 trillion systemic risk at the global iconic legends - Fannie Mae & Freddie Mac
Fannie Mae (The Federal National Mortgage Association) and Freddie Mac(The Federal Home Loan Mortgage Corporation) - the twin iconic GSE (Govt. sponsored enterprises) institutions that own or guarantee more than $5-6 trillion of the total 12 trillion mortgages have always been the legendary pillars of the US mortgage industry but their span of influence and prestige spread much wider across the entire financial markets around the world.
For sometime now, both the mortgage icons have been under tremendous pressure due to the sub prime, mortgage and housing crisis in the US market. Although they guarantee or own only half of the mortgage market, because the subprime mortgage crisis has caused almost all other lending sources to pull out of the market, they are responsible for more than 80% of new mortgages being made in 2008.
There was fervent hope from many informed quarters that these prestigious GSE's would somehow weather the perfect storm and lend the much needed stability to the mortgage market. More so as many U.S. banks as well as foreign governments own stock or debt in the two giants, implying gigantic proportion of the systemic risk beyond the US housing market.
But this week a new chapter in managing the gigantic systemic risk will be written via the US Treasury, Fed Reserve and the Federal Housing Finance Agency(FHFA) coordinated intervention at these 2 iconic firms. As of yesterday Sept 7th 2008, both firms are now under conservatorship of the FHFA.
GSE background - For a little bit of history, the US congress created Fannie Mae as a government agency in 1938, during the Great Depression, to buy government-insured mortgages from lenders, providing them fresh money to make more loans. In 1968 it turned into shareholding entity.
The government sponsored enterprises (GSEs) are a group of financial services corporations created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. The desired effect of the GSEs is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors: agriculture, home finance and education
Freddie Mac is a government sponsored enterprise (GSE) of the United States federal government. It is a stockholder-owned corporation, authorized to make loans and loan guarantees. It was created in 1970 to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending and increases the money available for new home purchases.
It's a rather dissapointing twist for the 2 legends that are bearers of more than $5 trillion of mortgages, having suffered combined losses of about $14 billion over the past four quarters as they make provisions for a wave of defaults.
The unique psrt is that both are profit making firms but with charter by US Congress to support the housing market. Being seen as backed by the government, their cost of funds was close to those of U.S. Treasurys.
Earlier the 2 firms explored raising capital through the sale of their common or preferred shares. But investors were not to keen given the uncertainity of federal action.
In days to come we will see the Treasury, Fed Reserve along with Federal Housing Finance Agency that oversees both Fannie Mae and Freddie Mac implement this conservatorship plan that amounts to almost takeover of these 2 institutions. These measures should help remediate and manage the 5 trillion systemic risk these two pose to the broader global markets.
The plan is injecting significant government funds into both over a period of time rather than one off along with management shakeup.
The US Treasury, Fed Reserve as part of their broader systemic risk mitigation efforts are reported to have been reaching out to reassure foreign central banks and other overseas institutional buyers about the creditworthiness of the debt and instruments issued by these 2 firms.
Other details:
Some of the plan of action items for the Federal Housing Finance Agency conservatorship are:
1. Business will be transacted normally, with stronger backing for the holders of Mortgage Backed Securities (MBS), senior debt and subordinated debt.
2. The Enterprises will be allowed to grow their guarantee MBS books without limits and continue to purchase replacement securities for their portfolios, about $20 billion per month, without capital constraints.
3. As the conservator, the FHFA will assume the power of the Board and management.
4. Appointed as CEOs are Herb Allison for Fannie Mae and David M. Moffett for Freddie Mac. Allison is former Vice Chairman of Merrill Lynch and for the last eight years chairman of TIAA-CREF. Moffett is the former Vice Chairman and CFO of US Bancorp.
5. To conserve over $2 billion annually in capital, the common stock and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. 6. Subordinated debt interest and principal payments will continue to be made.
6. There will be financing and investing relationship with the U.S. Treasury via three different financing facilities, to provide critically needed support to Freddie Mac and Fannie Mae and the liquidity of the mortgage market. One the three facilities is a secured liquidity facility which will be not only for Fannie Mae and Freddie Mac, and also for the 12 Federal Home Loan Banks that are regulated by FHFA.
The Treasury support programs and credit facilities being:
Four aspects of the U.S Treasury's support:
1. "To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size."
2. The Treasury and the FHFA has established Preferred Stock Purchase Agreements, contractual arrangements between the Treasury and the conserved entities. "Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations.
3. "The Treasury established a new secured lending credit facility, available to Fannie Mae, Freddie Mac, and also Federal Home Loan Banks. "This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July 2008, and will be available until those authorities expire in December 2009."
4. "To further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. Treasury will begin this a program later this month, investing in new GSE mortgage backed sequrities (MBS). Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009.[7]
Sources: WSJ
http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac
Posted by spachava at 04:31 AM
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