Saturday, August 11, 2007

Fannie and Freddie – A Little History and Lots of Politics

Excerpts below from a Market Watch article gives the recent background about Fannie and Freddie and the financial reasons why they are in the dog house with some politicians. The parts of the article that deal with politics have been excluded, but you have the link to the entire article above.

As stated in a previous post Fannie and Freddie are going to be very conservative in the loan criteria that they will apply, however they may be a good way to help stabilize the prime portion of the real estate market. Lenders always over react to bad news, so now, even the prime portion of the market is having problems. Besides it is time to get real about the Fannie and Freddie lending limit of $417,000. That does not get you much in many parts of the country anymore.

Once spurned by investors and targeted by lawmakers over their accounting scandals, Fannie Mae and Freddie Mac this past week staged a dramatic reversal of fortune, a comeback that was all the more remarkable as the rest of the financial-services sector seemed to be in a tailspin.

For more than three years, the mortgage giants have been kept on a short leash, laboring under special restrictions as part of the government's bid to limit the scope of their investments out of concern their shaky accounting posed a risk to markets.

But in recent days the markets reeled, and Fannie and Freddie were cast as possible saviors.

Fannie Mae set events in motion by asking regulators to let it buy more home loans in a secondary mortgage market that has gone sour as investors flee in fear.

Getting permission will be an uphill battle. Late Friday, the Office of Federal Housing Enterprise Oversight, which regulates the companies, rejected Fannie's request -- for now. Meanwhile, a drumbeat of support from the companies' allies in Congress is growing, calling for easing the restrictions on Fannie

And with a growing number of mortgage companies unable to find investors to back their loans, such calls seem likely to persist.

The time is right for Fannie Mae to step in to help ease market turmoil, according to Daniel Mudd, Fannie's chief executive. Fannie doesn't see the housing market decline leveling off until the second half of next year, Mudd told CNBC earlier this week. "The question now is what can we do to make that as moderate a downturn as possible," he said. "And the answer, to us, is liquidity."

For his part, Michael Cosgrove, a spokesman for Freddie Mac, said the company "certainly would be in favor of lifting the temporary growth limit on our retained portfolio."

But giving Fannie and Freddie back the freedom they once enjoyed is far from guaranteed, as the White House and other critics continue to argue that the two scandal-racked companies must stay on a short leash and their portfolios should be limited. Indeed, President Bush said he'd like to see reforms at the companies before an expansion of their investments. "First things first" when it comes to Fannie and Freddie, Bush told reporters at the White House.

Together, Fannie and Freddie's investment portfolios are worth about $1.4 trillion, a number that makes critics nervous. Republicans have long argued that a meltdown at either company could have devastating effects on the U.S. financial system.

Just three months ago, the House passed a bill tightening rules on the government-sponsored enterprises. It wouldn't cap the portfolios, except for reasons of safety and soundness, but it would create a tougher regulator with expanded powers to approve the companies' activities and capital. The Senate has yet to pass a companion version.

"The president said today that legislative reform of the GSEs should occur before he will consider lifting their portfolio cap," said Senate Banking Committee Chairman Christopher Dodd, in a written statement. "However, there is no reason why such reform is a necessary precondition to a modification of the cap that is done in a safe and sound manner," added Dodd, who also is running for president.

Fannie Mae's portfolio is capped at $727 billion. Meanwhile, the company is also operating under another restriction: Both Fannie Mae and Freddie Mac may only buy loans with an individual value of $417,000 or less.

Congress needs to address that issue, Mudd says. Now, rates on loans above $417,000 -- so-called jumbo loans -- have increased, stoking fears that credit problems are extending beyond the subprime sector of the market. Subprime loans are extended to borrowers with poor credit.

Another question is how much can be accomplished by easing the restrictions on Fannie and Freddie. Albert Kyle, a professor of the University of Maryland's Robert H. Smith School of Business, says that a move by Fannie and Freddie to buy more mortgages would boost the market temporarily but probably not for long.

"If anybody bought mortgages now, or anybody was willing to finance them ... that would help the mortgage market," Kyle said.

However, if there's an increase in defaults on prime mortgages -- the kind that Fannie and Freddie usually buy -- then the companies will be in trouble, he argued.

"Either the situation is going to sort itself out without their help or it will make their situations worse," Kyle said.

Congressional curbs were spurred by revelations of accounting debacles at the companies.
A year ago, Fannie Mae was fined $400 million after regulators found that senior executives manipulated books to reap bonuses for themselves. In 2003, Freddie Mac said it misstated earnings by $5 billion for the years 2000 to 2002. The McLean, Va.-based company paid a fine of $125 million and top executives were shown the door.

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