Fannie And Freddie’s Survival Spells Big Trouble For Housing Market

If these two companies Freddie Mac (FRE) and Fannie Mae (FNM) survive as private, beware. House prices will continue to fall, defaults, foreclosures and inventory will continue to surge, which causes house prices to fall and defaults, foreclosures and inventory to surge…….

Since CITI (C) and Goldman (GS) chimed in on how these two runaway, over-leveraged, risk-taking, quasi-Government hedge funds may survive privately without a loss to the common shareholders, debt holders and preferred holders, the market has calmed down and shares of the two have soared.

As a matter of fact, the financial sector in general is going well.  People are now convinced that the Fannie/Freddie problem is behind us.  But that could not be further from the truth. Kept private, these two companies will do much damage to the housing market going forward, which will ultimately lead to their demise and/or the bailout needed right now.

What I find most amazing is that other than suggesting that the Government buy mortgage securities from the companies and put the credit risk on the US tax payer, the only other options publicly discussed were to ‘hope for the best’ and ‘let the GSE’s lever-up even higher’. You must be kidding me!  CITI and Goldman must have fairly significant exposure.

The Goldman report listed other options, including “take no action and hope for the best” and reducing the companies’ minimum capital requirements. Goldman didn’t predict what the Treasury will do. The Citigroup report said the companies should have enough capital to get through 2008 based on credit-loss estimates. (WSJ Online)

‘Reducing the capital requirements’ just as the ratings agencies and GSE’s have admitted to Prime and Alt-A defaults surging is absolute insanity. Perhaps if there was even the most remote signs of the housing crisis abating, this would be an option. But as of this point in time, conditions just keep worsening and there is no light at the end of the tunnel other than a series of trains.

This problem must be solved now. The GSE’s are responsible for 80%+ of the US mortgage market and without them actively buying and guaranteeing mortgages, availability of credit will be further depressed.

Unless everyone starts paying cash for houses, the reduced availability of mortgages will cause house prices to fall further, which leads to more defaults, which leads to more foreclosures and inventory, which leads to further house price declines and so on and so on.

There are so many moving parts to this story and so many hands out that want a bailout, the Treasury is hamgstrung.  The raters went after the preferred shares for exactly this reason.

In another sign of uncertainty over the Treasury’s intentions, Standard & Poor’s Ratings Service late Tuesday downgraded its ratings on the preferred stock of Fannie and Freddie to BBB-minus from A-minus, matching a move last week by Moody’s Investors Service. S&P cited “increasing uncertainty” on whether government support “will extend to these securities.”

If they keep these companies private, mortgage lending and housing will suffer because the GSE’s will be forced to shrink their balance sheets. You have already seen what happens when affordable financing is taken out of the housing market.

Just look at CA home prices, which are off nearly 35% in the past 14 months. From 2003-2007, the mortgage lending in CA was primarily non-Agency and when that totally dried up in mid to late 2007, housing prices began their tumble towards the most readily available financing, which is Agency $417k and below.  House prices in CA fell 3% alone last month even as sales increased; a phenomenon rarely seen in history. Demand is supposed to drive prices.

In their latest monthly reports, Fannie and Freddie disclosed that they cut back on commitments to buy mortgage securities in July. Those purchase commitments, net of planned sales, totaled about $16.3 billion, down from $55.1 billion in June. The companies are providing less support to the mortgage market, while reducing their capital needs.

Fannie increased its holdings of “liquid” investments, cash and short-term securities that can easily be sold, to $103.6 billion, up 43% from June. The move gives the company more flexibility to reduce its future borrowings if market conditions worsen, company officials said.

Due to this, reports are now coming out that Fannie and Freddie are now wildly profitable and will be going forward. But again, their profitability spells doom for the housing market and their ultimate demise.

Bloomberg recently reported that:

“Fannie and Freddie’s holdings are shrinking at a monthly rate of about $20 billion because of refinancings, home sales and borrower defaults, according to an Aug. 21 report from New York-based Citigroup analysts Scott Peng, Brad Henis, and Brett Rose. That money can be reinvested into higher yielding securities. That is one reason “there is no pressing need” for a bailout, they wrote in the report, titled “All That Sound and Fury, Signifying Nothing New”.”

So, once again Fannie and Freddie can muddle through but the mortgage and housing market suffer. As housing prices fall, more are thrown into a negative equity position or a deep negative equity position, more are stuck in their homes unable to refi or sell and more will default.  This leads to more foreclosures, more supply and further house price declines. This is a nasty feedback look from which there is no escape unless mortgage lending expand and not contracts.

All this while the GSE’s are rasing rates and adding rate adjustments for things such as lower FICO’s and higher LTV’s that were never required before.  They are also doubling their ‘adverse market delivery charge’, which is essentially a seller paid hedge fee. This will get passed on by the banks directly to the borrower. A .5% spike in interest rates from this hit alone makes housing considerably  less affordable.  Rates are rising and are going even higher, there is no doubt. Incomes are not rising. Therefore, house prices must fall further.

The companies are also boosting fees to guarantee home-loan securities, off-balance-sheet obligations for which they don’t need to borrow. Fannie plans on Oct. 1 it will double to 50 basis points an upfront “adverse market delivery charge,” introduced this year for every mortgage the company buys or guarantees. (Bloomberg)

In a nutshell, anything done that preserves the GSE’s as private companies but also constricts their ability to lend or forces them to raise rates is a terrible thing. People keep reading the headlines and figuring ‘as long as Fannie and Freddie survive all is good’. That is not the case. They need to survive and supply aggressive financing or they are will exacerbate the housing problem and seal their own fate.

Posted in Categories: Contributor, Economy, External Research, USA.

Subscribe by RSS Subscribe by Email