NOTE: Freddie losses are being reported anywhere from 2 billion to 4.8 billion depending on the source (bloomberg, hotwire, etc...).

Thanks for the great market info as always.  I've read through twice and need a third or fourth reading to absorb it fully. 

As we spoke on the phone my friend, my opinion is that the European banks and investors are going to have to come to the rescue.  With the dollar in the toilet and Bush still spending on his own personal war, the real estate market hanging by a thread and people out of work, there are no American philanthropists who will support our flailing market.  Tey are too busy making infomercials and movies.  The more valuable currencies such as Europe and even Canada now are going to take advantage in my opinion and buy us low and then maybe sell us high in the future.

@ Ron - You mention on the phone about Paine Webber selling to European, UBS. As it stands, Middle East investment topped 25 billion this year alone. Recently purchasing GE plastics. That's 1 or 2 billion more than they've invested every year combined since 1990. Between them, Europe and emerging markets in Asia and India, what you just said is quite likely to unfold. The question is, will they wait for the implosion or be the bail out mechanism to Fannie and Freddie if times get that tough? Screw CW and WAMU, they are chump change in the grand scheme of things - IMHO.

@ Josette - Thanks so much for reading it. I wasn't sure if anyone was interested to be honest. The moral of the story is that we need to pay close attention to the health of Fannie Mae and Freddie Mac. Naturally, they're feeling stress-cracks from loan defaults, but if they do nothing to sway further defaults and grow capital to stay afloat, I see a bleak future for them, and us.

I don't want to be a downer though! Let's have a some Turkey and sleep on it! Who's cooking, you, hubby or are you visiting others for the holiday?

Michael :)

Michael, I was going to start my comment above with "well isn't that cheery" but then thought better of it becuase it is such a downer.  My head is spinning from the implications of our interwined global markets and the current mess.

So I just ate more pie and forgot about it for the day!  Usually I cook and my husband helps with the last minute chaos but this year we went to friends and just brought pies.  Hence the fact that I ate pie :)

Keep up the great posts.  I'm learning by leaps and bounds.  In fact if you look at one of my latest blog posts you'll see that I applied what I learned from you about clouded markets to my local area.  Scary to see what happens when this mess gets clustered in one spot.

Hi Josette,

Thanks such a great compliment. I'll check that post tonight. As for desserts, I have home-made Banana bread to munch on this weekend. mmmmmm good.

:)

Take care,

Michael

Michael,

Great article...

It's very interesting times we live in and I think we will see a fundamental and permanent change to how the mortgage industry operates.  The GSE's like Fannie and Freddie are truly in trouble right now.  You can look at Fannie cutting their dividend and announcing the $7B preferred stock offering to raise capital tonight as proof.  They are both highly overleveraged and undercapitalized with Fannie having about 28 times leverage against their equity, so it won't take much of a hit to underlying assets to put them in a world of hurt.  I think one of the key lines in there is:

"Hence - Fannie, Freddie and our Legislators are truly at crossroads and faced with a tactical decision with no guarantee of success."

If history is any guide, federal government intervention into these types of matters is rarely successful.  This type of stuff maybe a downer, but it's happening whether we want it to or not.

Bloomberg: Fannie cuts dividend, offers $7B in preferred

Thank you for the valuable and detailed information. Keep it coming!

Heather

thanks for the post... it is news we as realtors need to be updated on, to be the experts that the public relies on.

@ Matt - Thanks for the feature and comments. It all begins and ends with the GSE's. 

@ Heather - Will do.

@ Jeff - Your welcome.

Michael, your posts always amaze me and make my head spin.  Over a month ago I mentioned that foreign money will be the only salvation to our high rise market.  Most jumbos, very specialty and unique mostly second, vacation or investment properties

Hey Renee! Thank you so much. I too think its the same foreign money that will ultimately bail-out (buy-out) the GSE's. Check out this AP article today on the our National Debt...we ain't got the money. What the GSE's hold now and what they owe is just mind-numbing.

Interesting read. Thanks for sharing. All the best.

This is the  best explanation I've ever seen for this topic, and I've seen a lot of them in my day.  I'm so glad this was featured because I usually run out of time before I get to posts by appraisers, lenders, and stagers.  Congratulations on the gold star!

Michael: What a brilliantly written and infomative post. As someone who has written extensively about declining values in California, I had come to many of the same conclusions as you.

There is a great example in the car business of the value of a car when it cannot be financed...this is when a perfectly good car ends up with a "salvage" title from a theft. The car may be perfect, but the salvage title means no lender will finance the car....therefore it will only sell for about half of the "real" value since so few buyers can fork over $20,000 + to pay cash. Now apply that to real estate where the hit would probably be far greater, and you come up with a sobering scenario.

As a mortgage broker in a high value area, we have overcome this situation by placing a first mortgage at $417,000, then a large second to get to the loan amount we need. My auto leasing company (which I still own) informs me that already, almost every credit report they view has a mortgage amount of (you guessed it!) 417,000.

Alarmingly, lenders who are willing to do these seconds are disappearing rapidly after being the ones left holding the bag in a foreclosure situation. As you pointed out, this will limit the buyers who can buy, and depress values further.

Going back to the salvage title scenario...buyers willing to pay the difference in cash between a million dollar house and a $417,000 loan will be few and far between. Same buyers won't WANT to pay what it costs (a far higher amount) to get those jumbo loans that must be carried by the lenders (because loans exceed $417,000 & can't be sold)

What happens to the million dollar house? It is devalued as a result, of course! The ability to finance DOES have a huge impact on the value of properties.

Bob/Carolin - Thanks for stopping by.

Margaret - I *blush*. Thanks for the kind words.

Janet - Glad you stopped by. Your market sounds similar to many down here in SoCal. Since second loans* typically cap around $250,000 and a conforming first loan caps at $417,000, the combined loan amount of $667,000 yields a workable price range of $700,000 to $750,000 assuming 90% to 95% CLTV. The equation will change depending on how second lenders expand and contract their loan amounts. However, this only works if the market in question "is accustomed or able" to make down payments.

The problem most high-cost areas face here is the lack of access to 100% financing. The reason is that the demographics have not changed. The majority of buyers there are still not willing or able to make the hefty 5% or 10% down payments to make the sale. It's these markets that are getting pummeled the worst as the flight to conforming limits ensues where such 100% financing is still possible.

In short, access to financing and the way we finance today has absolutely everything to do with the value of real estate.

*To the best of my recollection...

Hi Michael - I'll take this one step further. As property values adjust, local governments will see declining tax revenues resulting in decreased services and hiring freezes. We've already seen this in Nevada. And as credit standards become tighter, discretionary spending will be scrutinized more and more, creating a ripple effect through local economies.

Will be interesting to see the year-end reports from Fannie and Freddie alongside those of the major homebuilders. This might give us a glimpse of where the housing market is headed in 2008 and beyond.

Congrats on the featured post.. although I'm afraid I'd rather keep my head in the sand with a good deal of it. 

Yikes!  Can anybody say "Reverse- Multiplier Effect?"

Hmmm.

You mentioned something about Pavlov the other day.. I'm afraid the resulting conditioned response for me with all of this is a head ache.

In all seriousness Michael, this was a very compelling and well documented post, much deserving of the feature.  Rock on.

John - That's exactly right. I too am curious about Q4 data.

Fred - You come by and I feel better. Strange? Not familiar with the term above but I'm sure whatever it is your on point. See you here pal.

Wow, just read over the details of Bush's proposed subprime bailout plan.  If it was actually implemented (which I think it has zero chance of) it would put a final bullet in the head of the mortgage industry.  Lets cap rates on ARM's for 5 years and stick it to the investors that bought the MBS's and CDO's.  Good luck ever getting investors to buy that stuff again if that happened.  Just had to vent, at the stupidity of it...

Update: Just posted on it http://activerain.com/blogsview/297319/Subprime-Bailout-Putting-another

Matt - "Mi blogo es' su blogo". Vent here anytime. Like you, I too await the third chapter to this suspence thriller a.k.a. the US housing market.

To Reader/Visitors: If you have not read Matt Heatons's post, please do so. The following comments here will make better sense.

Matt -

Your post and this post are quite interconnected at the back-end of the mortgage markets. Here's the connection I see. If this plan ("The Freeze") moves forward, without the standards prescribed by the ASF, then you are absolutely correct that demand for American non-conforming MBS's and the like investments will perish. It lends to reason that the demand for Fannie and Freddie guaranteed products (MBS's, CDO's, etc...) will remain or increase. The problem however is that if the Fannie and Freddie assets continue to decline (because in the real world upper priced homes continue to buckle overhead of their assets), then the salability of all American derived MBS's become suspect (if not wholly non-salable). In this instance, kiss F/F good bye and say hello to the 12%-20% rates of the past due to the supply/demand credit imbalance between the public and the few remaining portfolio banks.

Terrific explanation and analysis. Hope you follow-up with an analysis of today's news of the 5 year moratorium on ARM rate increases. 

Hi Marsha - Thank you. Coming from you, that's a great compliment. Hope to see you again soon.

Michael, great information was once again.

 The thing that continues to amaze me is the fact that most people don't realize that Fannie & Freddie both have been purchasing subprime loans for some time now.  A lot of their losses came from investments in the CDO's.  I think both Fannie & Freddie stepped over the fine line between increasing homeownership and greed.

Unfortunately, the problems they are going up against will cause problems for all of us.

What is left of sub-prime loans is being underwritten to standards to be able to sell to Fannie or Freddie.  Leaving everyone with 3 outlets:  Fannie, Freddie, FHA.

Over the years the standards at these 3 have changed significantly, and they allow for great opportunities.

Jeremiah - Here's a release of Fannie's amendments to Selling guides introducing 'Adverse Market' Charges. I don't recall if you sent me this before. But from the looks of it, the Homebuilder's association is up in arms over it. NAHB Slams Fannie's Plans for ‘Adverse Market' Charge

The most interesting amendment is in this announcement regarding Interested Party Contributions...

Michael - Thanks for pointing out that this indeed is a global issue.  It's so easy to fall into the trap of thinking ethnocentrically.  Thanks for the wake up call.

Good article. I still why the market has not introduce new loan types. It seems that they are just playing the game the way it has been for the 50 yrs.  Banks could still fine plenty of money to be made with 40,50, heck 100 yrs loans.  Home prices are reaching levels where the likelihood of full pay off is minimal.  Monthly cash flow is becoming the issue.

Good post!  i always try and educate my clients about the secondary mortgage market and what that means for them.  I've got this bookmarked!

Well written and very informative.  Thanks for the links to references as well.  This is one issue everyone in real estate should keep up with and not stick their head in the sand thinking it will all go away. 

Marlene - My pleasure and thanks for reading.  

Scott - I think of it like this: The investment lords up above are playing Vegas craps with the US housing market. The more complicated they make the investment vehicles the more risk they take overall, which means more money can be made...and lost.

Melina - Thank you. Glad you came by.

Hi Fran,

You are absolutely right. It will not go away. The ball to keep our eyes on is the GSE's... They win, we win...they lose, we lose... FHA alone can not finance our mortgage debts.

Congrats on the Featured Post.  Well deserved. 

Your post reminded me of the Multiplier Effect we learned about in Economics.. the way a single dollar spent can have a rippling effect across the economy. 

When you said..."....the decline in prices of more desirable markets cause a trickle down price effect crushing equity below it. "  it made me think of a sort of Reverse Multiplier.

Just another twisted vision of mine from who knows where.

Fred,

It makes perfect sense...twisted or not so thanks for clarifying. Feel free to indulge in the obscure on my posts anytime.

It appears that legislators are going for the "Hail Mary" from hell with provisions in the stimulus bill raising conforming limits across the board to $625,000, and $730,000 +/- in high cost MSA's.

Heres' the Inman Article. Pay close attention to the concerns expressed by James Lockhart, OFHEO director. I don't blame him...

Congress OKs stimulus bill, loan limit increase
Fannie, Freddie to venture into jumbo loan territory
Friday, February 08, 2008

By Matt Carter
Inman News

Bush administration officials renewed their calls for Congress to pass legislation tightening oversight of Fannie Mae and Freddie Mac Thursday, as Congress signed off on a plan to allow the companies to guarantee or purchase loans that exceed the $417,000 loan limit.

Senate Democrats on Thursday abandoned an attempt at a broad expansion of a $150 billion economic stimulus bill backed by the Bush administration and approved by the House last month.

In an 81-16 vote, the Senate sent a slightly modified version of the bill back to the House, which promptly voted 380-34 to put the bill on the president's desk.

The White House issued a statement saying President Bush could support the Senate's more limited amendments, which expand the pool of those eligible for tax rebate checks to include $300 payments to Social Security recipients and disabled veterans.

Bush said the bill "would quickly put money into the hands of the American people and provide our economy the boost it needs" and that he will sign it into law.

The economic stimulus package includes a provision that will temporarily raise the conforming loan limit to allow Fannie and Freddie to purchase or guarantee many jumbo mortgages originated between July 1, 2007, and Dec. 31, 2008.

The increase, to as much as $729,750 in high-cost areas, will also apply to Federal Housing Administration loan guarantee programs. Because the increase will be capped at 125 percent of the median home price for an area, the conforming loan limit will remain at $417,000 in markets where the median home price is $333,600 or less.

Although the increase will expire at the end of the year, industry groups like the National Association of Realtors have urged Congress to mandate a permanent increase in the conforming loan limit in passing legislation to increase oversight of Fannie and Freddie.

Permanent changes to FHA loan limits are being addressed in bills that would also lower minimum down-payment requirements and expand the pool of eligible borrowers by using risk-based pricing. Both the House and Senate have passed FHA modernization bills, but differences between them are being ironed out (see Inman News story).

Buying or guaranteeing jumbo loans will present new risks for Fannie Mae and Freddie Mac, and increase their exposure in risky real estate markets such as California, the federal official responsible for overseeing their safety and soundness told Senate lawmakers Thursday.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said underwriting the larger loans will require new models and systems, which could take months to put in place. As Fannie and Freddie get set to venture into what is now jumbo loan territory, Congress must act quickly to ensure they don't put themselves -- and the entire financial system -- in jeopardy, Lockhart said.

Constraints placed on Fannie Mae and Freddie Mac in the wake of the management and accounting scandals that shook both companies in 2003 and 2004 helped limit their losses during the housing downturn, Lockhart said.

But as Fannie and Freddie put those scandals behind them and prepare to start purchasing and guaranteeing loans that had previously been off limits, Congress must pass legislation creating a strong, independent regulator to oversee their safety and soundness, he said.

Since August, when investors who financed mortgage lenders during the housing boom stopped buying most mortgage-backed securities not guaranteed by Fannie and Freddie, the companies have played a crucial role in providing liquidity, stability and affordability to the mortgage markets, Lockhart said.

He said the government-sponsored entities, or GSEs -- Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks -- are now financing or guaranteeing up to 90 percent of mortgage originations.

"The GSEs have become the dominant funding mechanism for the entire mortgage system in these troubling times," Lockhart said in testimony before the Senate Banking Committee. In doing so, "they have been reducing risks in the market, but concentrating mortgage risks on themselves."

Fannie and Freddie reported combined losses of $3.5 billion during the third quarter, and both companies are expected to post annual losses for the year -- the first annual loss in Freddie Mac's history, and the first in 22 years for Fannie Mae.

The losses stem mostly from write-downs of investments, rather than borrowers defaulting on loans Fannie and Freddie have purchased or guaranteed. Fannie and Freddie hold about $230 billion in mortgage-backed securities (MBS) that carry AAA investment-grade ratings but are backed by subprime or alt-A mortgages, analysts at Credit Suisse estimate. Credit Suisse analysts project the companies could be forced to recognize $16 billion in fourth-quarter write-downs in the value of those securities.

The potential write-downs identified by Credit Suisse are greatest at Freddie Mac -- between $8 billion and $11 billion -- which reports fourth-quarter results Feb. 28. Fannie Mae faces an estimated $2.5 billion to $5 billion in MBS write-downs, according to Credit Suisse.

Lockhart told Senate lawmakers he thinks Credit Suisse's projections are too high, but said allowing Fannie and Freddie to expand their loan purchase and guarantee activities "would be imprudent unless (regulators have) significantly more powers and more flexibility to use those powers."

Thursday's hearing was held before the Senate signed off on the economic stimulus package that includes the temporary increase to the conforming loan limit.

The White House had opposed increasing the conforming loan limit unless Congress passed legislation tightening oversight of Fannie Mae and Freddie Mac. But Treasury Secretary Henry Paulson last month agreed to a temporary increase in the limit as part of the economic stimulus bill approved by the House. Paulson said he did so because Democratic leaders, including Senate Banking Committee Chairman Chris Dodd, promised to take prompt action on so-called GSE reform legislation.

Although the House has passed bills that would strengthen oversight of Fannie and Freddie -- most recently last May -- disagreements over limits on the GSEs loan portfolios and minimum capital requirements have been obstacles to Senate passage.

Thursday's hearing was held as Dodd and Sen. Richard Shelby, R-Ala., draft their own version of a GSE reform bill. Dodd promised prompt action on the issue, saying he and Shelby have proven capable of working together to draw up legislation in the past.

Fannie and Freddie are currently regulated by OFHEO, while the Federal Home Loan Banks are regulated by the Federal Housing Finance Board. The GSE reform bill passed by the House last year, HR 1427, would abolish OFHEO and FHFB and create a single, independent regulator to oversee the GSEs. The new regulator, the Federal Housing Finance Agency (FHFA), would be granted powers similar to those of bank regulators.

Assistant Treasury Secretary David Nason told members of the Senate Banking Committee that the new regulatory agency should have the power to place the companies into receivership if they become insolvent.

Treasury officials have waned that the perception that the government will bail Fannie and Freddie out if they run into financial trouble causes investors to underestimate the risk of lending money to Fannie and Freddie or investing in securities they guarantee.

"Providing the new regulatory agency the ability to complete an orderly wind down of a troubled regulated entity also encourages greater market discipline by clarifying that investors may suffer losses," Nason said.

Nason and Lockhart said FHFA should have more flexibility in setting minimum and risk-based capital requirements. By statute, Fannie and Freddie are required to maintain capital equal to 2.5 percent of assets, and Congress also created a rigid stress test for determining risk-based capital requirements.

Lockhart said OFHEO needs more flexibility to regulate minimum capital, and that the current stress test for risk-based capital requirement "is just not working, as it has yet to capture the risks we are currently observing."

Lockhart said the losses Fannie and Freddie are reporting now would have been greater if not for consent agreements the GSEs entered into, after accounting and management scandals forced both companies to fire top managers and restate several years of earnings.

The agreements restricted growth in the GSEs' loan portfolios, and boosted capital requirements by 30 percent, to 3.25 percent of assets.

"In retrospect, those agreements ... especially, the growth restrictions and the capital requirements, were extremely important in reducing the credit losses at Fannie Mae and Freddie Mac and preventing major disruptions of the conforming loan market system," Lockhart said.

Fannie and Freddie have made "major progress" toward instituting the management and accounting changes called for in the agreements, Lockhart said, and in September OFHEO eased restrictions on the GSEs' loan portfolios to allow 2 percent annual growth.

The portfolio restrictions will be lifted altogether when Fannie and Freddie return to regular financial reporting, which Fannie will do by the end of the month, Chief Executive Officer Daniel Mudd testified.

Lockhart said Fannie and Freddie have not yet utilized the additional capacity, and could grow their combined portfolios by $100 billion in the next sixth months, to $1.5 trillion, without bumping up against the new limits.

Higher capital requirements instituted in the wake of the scandals have also restricted Fannie and Freddie's growth, requiring them to raise nearly $14 billion during the fourth quarter by selling preferred stock and cutting dividends to shareholders.

The move to boost capital requirements by 30 percent, which was instituted four years ago, "was the right thing to do at the time," Freddie Mac Chief Executive Officer Richard Syron said in his written testimony to the committee.

But requiring the GSEs to maintain "the same leverage ratio as banks" would require Fannie and Freddie to institute "enormous price increases" and threaten their ability to provide liquidity to mortgage markets, Syron said. The new regulator should only be given the power to increase minimum capital standards temporarily, Fannie and Freddie executives said.

Lockhart insisted that the existing 2.5 percent capital requirement -- and the temporary increase imposed in the aftermath of the accounting and management scandals -- are low compared to other financial institutions.

Syron said Freddie Mac executives are also "very concerned" about the prospect of Congress imposing more stringent affordable-housing goals, saying "a disproportionate share" of credit losses come from loans that qualify for affordable-housing goals.

When asked by Sen. Shelby why Fannie and Freddie had purchased so many non-agency mortgage-backed securities as investments, Lockhart said those investments helped the GSEs meet affordable-housing goals set by the Department of Housing and Urban Development (HUD).

Nason and Lockhart said creation of a new independent regulator would remove HUD from the process of approving new loan programs, setting housing goals, and oversight of Fannie Mae and Freddie Mac.

From one of my faves...Housing Wire. 

What if Fannie and Freddie Can't Prop Up Housing?

By Paul Jackson  •   March 7, 2008  •   Comments

The question on the minds of both investors and mortgage banking executives as this week comes to a close is one they never thought they'd ask: what if Fannie and Freddie aren't the answer?

It's a scary thought. The two government-sponsored entities have been charged with ensuring liquidity in the secondary market for mortgages, a mission that has become critical to the U.S. housing market as the country endures its worst housing slump since the era of the Great Depression. It's a role the GSEs have played before, but never on such a grand scale - and never with so much of the nation's economy riding on their collective backs.

And, up until now, theirs has been the only part of the mortgage market that's still working. Which explains why everyone is running headlong into orginating for the conforming market, or attempting to expand the definition of what conforming loans should be.

This week, Housing Wire was among the media that reported yield spreads on agency-backed mortgage bonds had reached levels not seen in more than 20 years, as the prices of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac plunged.

Regardless of the myriad of reasons likely driving the price drop, one fact remains crystal clear: the GSEs' collective ability to keep the mortgage market moving has diminished, even if only for the short term and even if just the result of frenzied deleveraging by hedge funds and other investors on Wall Street. The result? Higher mortgage rates.

One industry source, with more than 25 years in mortgage banking, told Housing Wire yesterday... (Click to Continue) 

People, this could get ugly...

From Bloomberg:

Freddie Mac, Fannie Mae Plunge on Concern Over Losses (Correct)
By James Tyson

(Corrects company names in headline.)

March 10 (Bloomberg) -- Freddie Mac and Fannie Mae, the largest U.S. mortgage finance providers, plunged to the lowest since 1995 in New York Stock Exchange trading on concern they may face increasing losses as the housing slump deepens.

Freddie Mac fell as much as 16 percent after Credit Suisse analyst Moshe Orenbuch said the McLean, Virginia-based company may have writedowns of as much as $5 billion because of losses on some mortgage bonds. Washington-based Fannie Mae dropped as much as 19 percent after Barron's said its solvency may be tested.

The declines wiped out about $4.5 billion from the combined market value of the government-chartered companies. The comments by Credit Suisse analysts added to concern Fannie Mae and Freddie Mac may need to raise extra capital after recording fourth- quarter losses totaling $6 billion as credit costs soared.

``There is a risk of a significant writedown'' on subprime securities Orenbuch said. ``This could further trigger additional writedowns and need for new common equity.'' He continued to forecast Freddie Mac will ``underperform,'' the rating he also maintains on Fannie Mae.

Freddie Mac declined $2.46, or 13 percent, to $17.19 at 1.08 p.m. in New York Stock Exchange composite trading, while Fannie Mae fell $2.87, or 13 percent, to $19.90.

Subprime Writedowns

Freddie Mac would need to take larger writedowns if the company marks to market half of its portfolio of subprime mortgages and mortgage bonds, Orenbuch said. The analyst downgraded his share price estimate to $16 from $22 and said the company probably will report a loss of $4 a share this year, compared with a previous prediction of $2.25.

Ratings companies have already downgraded 20 percent of Freddie Mac's subprime asset-backed securities and 15 percent of its total investment portfolio, said Orenbuch, based in New York. Freddie Mac has about $100 billion of subprime securities, accounting for about 65 percent of the company's asset-backed portfolio that doesn't carry a guarantee by a government- sponsored enterprise, the company said Feb. 28.

While Fannie Mae's reported net worth of $45.4 billion is higher than the minimum capital required by federal regulators, its leverage with assets at 20 times net worth leaves ``little room for error,'' Barron's said in its March 10 issue.

... (Continue Reading)

thanks for the information

This article should come as no surprise to anyone following the GSE's every move. The question raised here is: If GSE capitalization gets too thin, would we be headed towards "Nationlized Mortgages"...

(be sure to click-through to follow the story)

Fannie, Freddie Face "Severe" Capital Pressures, Say Analysts

By Paul Jackson  •   March 21, 2008  •   Comments  •   ShareThis

Both Fannie Mae and Freddie Mac face strong capital pressures, even as a Federal regulator has eased up on prior limitations in an effort to boost liquidity in the mortgage-led secondary markets. According to a report published this week by analysts at UBS Investment Research, both GSEs continue to face a likely need for fresh capital.

"As we have looked critically at these organizations, it is clear that there is a conflict between their mission - to guarantee as many mortgages as they can to keep the housing market from going into freefall - and the fact that they are thinly capitalized," the analysts wrote.

Counting measures put in place by OFHEO this week, Fannie Mae and Freddie Mac are currently sitting on $7.1 billion in excess capital each. Yet both face multi-faceted losses from their exposure to mortgage insurers, continued expansion of their guarantee business, as well as potential mark-to-market losses with each company's retained portfolio, UBS said.

The fair value of Fannie's exposure to mortgage insurers alone, for example - estimated by the GSE at $4.6 billion in the fourth quarter - is itself more than half of the excess capital now available to it.

Yet, despite expected losses elsewhere, it's the more immediate mark-to-market activity in each GSE's retained portfolio that may ultimately prove to be the most problematic. It shouldn't be hard for regular HW readers to fathom why, if you've been reading our front-page coverage recently.

UBS analysts estimated that, net of write-downs already on the books for Q4, Freddie Mac could face as much as $30 billion in write-downs in the first quarter of 2008. Likewise, Fannie Mae faces a possible $15.5 billion in write-downs, based on UBS' pricing estimates. Whether such substantial expected write downs would impact regulatory capital... (Continue Reading)

With a 66% percent drop in asset values, I would think Fannie is officially undercapitalized. I wonder what rating agencies have to say about this...

From this morning's FT.com:

Fannie Mae to raise $6bn new capital
By Michael Mackenzie in New York
Published: May 6 2008 13:45 | Last updated: May 6 2008 14:38

Fannie Mae, the largest buyer of mortgages in the US, on Tuesday reported a first-quarter loss of $2.2bn, posted credit loss provisions of $3.1bn and said it would seek $6bn in new capital as the deteriorating housing market extracted a heavy toll.

Fannie, a government sponsored enterprise (GSE), swung to a loss of $2.57 a share as home delinquencies and foreclosures rose. This was in sharp contrast with a $961m or 85 cents a share profit for the first quarter a year ago. Credit losses were $249m a year ago.

The company warned that housing faced "severe weakness" and that house prices would fall by 7-9 per cent in 2008, raising the prospect of further mortgage defaults and home foreclosures.

Fannie said an estimate of its fair value of net assets was $12.2bn at the end of the first quarter. This was 66 per cent lower than the value of $35.8bn assigned at the end of December. The fair value estimate is an off-balance-sheet measure that Fannie uses to report mark-to-market losses.

The capital raising will consist of selling common stock, convertible and non-convertible preferred stock, and Fannie will also cut its quarterly dividend to 25 cents a share from 35 cents beginning in the third quarter.

Fannie's stock price fell more than 7 per cent to $26.24 at the open and was down 5.1 per cent at $26.84 in early morning trade.

The annual cost of credit default insurance for Fannie rose to $50,000 per $10m of debt from $43,000 after the earnings release.

(Click to Continue) (emphasis added)

Richard Shelby and I share similar concerns over the GSE's.

From the Financial Times:

Fannie and Freddie capital alert
By James Politi in Washington
Published: May 13 2008 23:38 | Last updated: May 13 2008 23:38

The government-backed mortgage companies that finance the bulk of new US home loans may not have enough capital to withstand the plunge in the country's housing market, according to one of Washington's most senior financial legislators.

In an interview with the Financial Times, Richard Shelby, the senior Republican on the Senate banking committee, said Fannie Mae and Freddie Mac were "thinly capitalised, highly leveraged and pose a systemic risk to taxpayers".

"I worry about the failure of the institutions," he said. "My interest ... is to try to make sure they are strong enough financially to withstand a real downturn in the housing market."

The two companies are perceived to have implicit government backing which investors believe would trigger a bail out in the event of collapse, but the government has never had to exercise the guarantee.

(Click to Continue)

OMG! It's happening...

And the stress cracks widen...

From Housing Wire:

Fannie, Freddie Downgraded by Moody's
By: PAUL JACKSON
July 15, 2008

The hits keep on coming for Fannie Mae (FNM: 7.47 -23.23%) and Freddie Mac (FRE: 5.40 -24.05%). Tuesday morning, Moody's Investors Service said it had downgraded key credit ratings at both GSEs over concerns about "diminished financial flexibility." Fannie saw its preferred stock rating fall to A1 from Aa3, while its bank financial strength rating was knocked to B- from B; Freddie saw similar cuts to its preferred stock rating and financial strength, as well.

(Continue Reading)

Links [Courtesy of HW]: Moody's statement on Fannie, Moody's statement on Freddie