Letter to the Editor

To the Editor:

The day before the Underwear Bomber pulled up his loaded drawers, the Treasury set off its own bomb. The media covered the Fannie Mae/Freddie Mac story on Christmas Day, but only those in the financial community paid much attention. Perhaps there was too much distraction.

U.S. Treasury Ends Cap on Fannie, Freddie Lifeline for 3 Years

Dec. 25 (Bloomberg) — The U.S. Treasury Department will remove the caps on aid to Fannie Mae and Freddie Mac for the next three years, to allay investor concerns that the companies will exhaust the available government assistance.

The two companies, the largest sources of mortgage financing in the U.S., are currently under government conservatorship and have caps of $200 billion each on backstop capital from the Treasury. Under the new agreement announced today, these limits can rise as needed to cover net worth losses through 2012.

Fannie Changes Clear Way for ‘Large-Scale’ Buyouts

Dec. 28 (Bloomberg) — The U.S. government’s expanded capital backstops and portfolio limits for Fannie Mae and Freddie Mac increase “the prospect of large-scale” purchases by the companies of delinquent mortgages out of the securities they guarantee, according to Credit Suisse Group analysts.

— Bloomberg News

Taking this action before the close of the year allows the Treasury Department to get around Congress. Next year, it would have been required to request any new funds from Congress. With these new caps they can absorb big losses. It will allow F/F  to start buying back the worst loans from bond pools, so they take the hit, rather than investors. Then the pools trade up, to lower interest rates, keeping mortgage rates down in an attempt to re-inflate the bubble. (It won’t work) F/F will buy toxic loans at higher than value prices and pass the bill to the taxpayers.

It does beg the question, whose balls got burned the most?

— Kelly Cowan

3 thoughts on “Letter to the Editor”

  1. Dear Eric,
     
    As someone who actually invest Fannie Mae and Freddie Mac securities for a living, the information from this letter was absolutely misleading.  The GSEs (Fannie and Freddie) buyout the worst loans generally DOES NOT favor the investors, and this is why:  the worst loans are typically the ones with higher interest rates, and therefore, were sold at premium dollar when packaged into mortgage-backed securities.  Considering this, you paid $103 for a bond.  The slower the bond gets paid off, the better off you are.  This is because you own the larger size bond longer, therefore, collecting more interest on the bond.  When loans get bought out of the security pool, the investors get $100 back for the portion that was paid at $103, how is that good for investors?  I should probably also clarify that securities backed by Fannie and Freddie are guaranteed against loss on principal and interest to begin with.
     
    The author of this letter was obviously confused between Agency securities (FN and FH) and Non-Agency securities.  The Non-Agency securities are the ones that contain loans didn’t fit into GSEs purchase guidelines, and are typically issued under the private shelves (like yours truly Bear Stearns or Lehman Brothers).  Loss on principal and interest for these type of securities are not guaranteed.
     
    Deborah

    =============

    Kelly replies:

    Eric, all this jargon misses the big picture.

    FNM/FRE are insolvent. Without government support they would be bankrupt. The guarantees are worthless without government funds (taxpayer money). FNM/FRE certainly don’t have the funds to make the guarantees.

    The government implied guarantee is not explicit. Of course with the new lack of caps (unlimited backing from the Treasury), it is certainly acting that way. This is another bailout. And remember China is a big holder of bonds issued by FNM/FRE.

    Without the bailout, an investor would choose to get a prepayment. The other choice would be no interest and loss of principal, which is certainly what they would have without the government backing of the FNM/FRE guarantee.

    If she works for an investor in RMBS (residential mortgage-backed securities) she knows better. Or she is living in a world that assumes that FNM/FRE RMBS have no credit risk, which would certainly not be true if the Treasury did not continue to bail FNM/FRE out. Her yellow brick road would not end at the Emerald City without taxpayer assistance.

  3. Kelly (and Eric), thank you. Enough to take the breath away. There is a crazy logic to it but not even Han Solo could delude himself into thinking such a desperate move could work. Assuming some shred of sanity among those who developed and who will implement this strategy, it could only be a play for time – but for what purpose?

    As to “balls” and “burned” i would suggest that the terms be separated. First, one surely does not need gonads to be among those burned by this case of klutz. Indeed, anyone even remotely involved with the established order will get sa singe on the short and curly’s. Second, such a decision takes balls so big as to render even pleated pants asunder.

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