Treasury, Fed Out to Entrap Fannie and Freddie?

I wrote that Fannie Mae (FNM) and Freddie Mac (FRE) should beware of Treasury Secretary Paulson’s message in "The Bear Lesson for Fannie and Freddie". First, Paulson encourages them to raise more capital and take on more risk. Then he implies that their shareholders bear the moral hazards of the companies’ actions. The Wall Street Journal’s "For Freddie, Fannie, It's Policy vs. Profit” explains that previously the Bush administration wanted to shrink the GSEs.

Federal Reserve Chairman Bernanke joined the “raise more capital” chorus at the Senate Banking Committee hearings today (April 4, 2008). At the same time both Bernanke and Treasury Undersecretary Robert Steel said that failure of the GSEs would present systemic risk to the financial system. Basically, the GSEs are too big to fail. (Dow Jones Newswires, Henry J. Pulizzi and Brian Blackstone, 4/3/08 1:04 PM EDT)

Sen. Charles Schumer is “exasperated” that Fannie and Freddie are imposing risk based fees and are not aggressively raising capital. He calls their fees a “tax on homeowners.” Even Alex Pollock from the American Enterprise Institute thinks Fannie and Freddie should be nationalized. Former Federal Reserve Chairman Paul Volcker said that he regrets that they were privatized. Talk about strange bedfellows.

The WSJ talks about three constituencies: politicians, the GSEs mission, and the companies’ shareholders. The biggest risk for Fannie and Freddie is that by not cooperating, they will incur new regulation. Legislators will demand they take on more risky low-income homeowner loans in exchange for the implied government guarantee.

The WSJ estimates that Fannie and Freddie will either purchase or guarantee 80% of new home loans this year. Both companies cited increased fees as the route to future profitability in their conference calls. Fannie recently announced that it will not guarantee or purchase any loans that have FICO scores bellow 580. So far this year, these companies have embarked on a route of writing profitable business. Let’s hope that they can prevent their mission from dragging them astray.

Disclosure: Author is long FNM and FRE.

Comments

[DCBill]

The GSEs always have operated under three conflicting objectives, mission, safety and soundness, and satisfying shareholders.

And, it is possible--successfully... do all three, if your regulator hasn't interfered too much in the day to day operations of your business and hiked up your capital requirements, beyond reason--which OFHEO has.

The GSEs won't be able to perform, let alone thrive, until the Bush Administration is history or enough of its political appointees leave town.