Freddie Mac Moves to Contain Subprime Fallout

Facing shaken financial markets over growing subprime lender bankruptcies and warnings, big bank (HSBC, New Century) reports of record subprime losses and Congressional hearings into predatory subprime lending, government-backed mortgage buyer/lender Freddie Mac announced Tuesday that effective Sept. 1, it would no longer buy subprime mortgages with excessive payment resets or high default probability. Freddie Mac will now require stricter salary documentation and repayment capability proof, and will only buy teaser rate loans where borrowers qualify for the higher reset rate. The firm is developing alternative subprime loans with longer fixed-rate terms, and is also encouraging prime loan practices by setting up escrow accounts for borrowers tax and insurance payments. The ABX index tracking BBB- subprime mortgage-backed bonds has risen 250% since November, to 1,400 basis points. Freddie Mac's sister government mortgage-backer Fannie Mae is choosing to wait-and-see. Instability in the $605 billion of 2006 subprime loans -- 20% of the $8 trillion mortgage market -- has stoked fears that the ABX will affect the higher rated AAA index, portending widening credit problems and continuing housing declines. Freddie Mac was down -1.89% yesterday to $63.70.

Sources: MSN Money, Forbes, New York Times, Wall Street Journal, Washington Post, San Jose Business Journal
Commentary: Easy Money Meltdown • A Low-Risk Long/Short Financial Institution Arbitrage Strategy • Rise in Sub-Prime Defaults Leave Investors Asking Who's Next...
Stocks/ETFs to watch: Freddie Mac (FRE), Fannie Mae (FNM). Competitors: Citigroup (C), Countrywide Financial (CFC), New Century Financial (NEW), HSBC Holdings (HBC), Accredited Home Lenders Holding Co. (LEND), Novastar Financial Inc. (NFI), American Home Mortgage Investment Corp. (AHM), Fremont General Corp. (FMT). ETFs: SPDR Homebuilders (XHB), iShares Lehman 7-10 YR Treasury Bond (IEF), iShares Lehman 20+ YR Treasury Bond (TLT)

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