This FHFA/Treasury in Historic Takeover of Fannie and Freddie
On Sunday morning the new GSE regulatory agency placed Congressionally chartered mortgage giants Fannie Mae and Freddie Mac into separate conservatorships, with the government committing $100 billion to each, while removing their CEOs, and laying the groundwork for a radical and historic restructuring of the entire U.S. mortgage market.
As part of the GSE restructuring plan, the Treasury Department is providing capital and funding support in an effort to boost investor confidence in Fannie and Freddie's $5.2 trillion worth of debt and mortgage-backed securities. "Monday morning the businesses will open just as usual, only with stronger backing for the holders of MBS, senior debt and subordinated debt," Federal Housing Finance Agency director James Lockhart said.
The Treasury has committed to purchase new Fannie and Freddie MBS, a move that will add liquidity to the mortgage bond market. It will purchase $5 billion worth of agency MBS in September alone. The FHFA dismissed Fannie CEO Daniel Mudd and Freddie chairman and CEO Richard Syron. The two men will remain on in transition roles. Herb Allison, a former vice chairman at Merrill Lynch, was named CEO of Fannie, and David Moffet, former vice chairman of U.S. Bancorp will lead Freddie.
The new CEOs will be charged with examining Fannie and Freddie's "guarantee fee structure with an eye toward mortgage affordability," Treasury secretary Henry Paulson said. "The primary mission of these enterprises now will be to increase the availability of mortgage finance," he said. The FHFA director placed the GSEs in conservatorships due to their ailing financial condition and their deteriorating ability to support the mortgage market. Secretary Paulson made conservatorship a prerequisite for providing the two GSEs with quarterly capital infusions to ensure they maintain a positive net worth. "I support the director's decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs," Mr. Paulson told reporters Sunday morning.
In agreeing to a conservatorship, the GSEs each issued $1 billion in senior preferred stock to Treasury. With each capital infusion, Treasury will accumulate more preferred stock. Treasury also will be issued warrants that give the agency the right to purchase 79.9% of the common shares in each GSE. Meanwhile, the government sponsored enterprises can increase their MBS purchases by about $100 billion each. But the investment portfolios are capped at $850 billion through 2009. The senior preferred stock covenants also require the GSEs to reduce their portfolios by 10% a year starting in 2010 until the portfolios reach $250 billion. The new conservatorships will not pay dividends on common or preferred stock. The Treasury secretary advised banks and thrifts with large exposures to GSE common and preferred shares to work with their regulators in developing a capital restoration plan.
News Analysis: A Radical Industry Restructuring is Upon Us
Mark Sunday morning, September 7, 2008, as the day the residential mortgage business changed forever.
In the months ahead, seller/servicers that upstream their mortgages to Fannie Mae and Freddie Mac may see little change in the way they conduct business with the two but rest assured the Treasury Department under Hank Paulson has laid the groundwork for the eventual dismantling of these once politically powerful (and once highly profitable) government chartered enterprises.
Over the long haul the takeover of the two GSEs could set the stage for housing deflation the likes of which Americans have not seen since the Great Depression and then some. With less liquidity in the mortgage market that means less home buyers and less home buyers creates intense pricing pressure on the downside. And maybe that's not such a bad thing -- in a way. In can be argued that Fannie and Freddie -- and Wall Street which pumped up the subprime sector from 2002 to 2007 -- made it too easy for too many Americans to buy homes. Too many buyers meant home prices rose ridiculously in such once hot markets as California, Florida, Arizona and New York. The days of easy mortgage money are over. Downpayments once again will become the norm as 'liar loans' and 100% financing disappear.
Eventually, Treasury wants the two to whittle down their on-balance sheet portfolios to $250 billion, about one-third of where they are today. Once the two GSEs stabilize, whoever sits in the White House will move to find a long-term solution to Fannie and Freddie. They could survive as separate smaller companies with Congressional charters or they could be made into one government agency that serves only low and moderate income Americans. If that happens the mortgage business likely will shift back to portfolio lenders like savings and loans, banks, and credit unions. The loans these institutions make will be placed on their books and kept for the long haul -- which is what the business was like until S&L crisis of the 1980s.
One thing is for certain: the mortgage industry of the past two decades -- one where most residential loans were sold to Fannie, Freddie and Wall Street firms like Bear Stearns, Merrill Lynch and Lehman Brothers -- is on the road to extinction. What lies ahead could spell opportunity or death for today's surviving seller/servicers.
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