Housing's Risky Reliance on Fannie Mae, Freddie Mac

Tuesday’s New York Times examines the extent to which the US housing market is dependent on Fannie Mae (FNM) and Freddie Mac, (FRE) and wonders whether a further decline in house prices could put the government-sponsored enterprises in deep trouble.

News of much-worse-than-expected first-quarter numbers at Fannie Mae and a plan to raise $6 billion in capital only adds to the concern. However, the company’s stock price actually rose, as the Office of Federal Housing Enterprise Oversight said it will lower requirements for surplus capital to 15 percent from 20 percent once the money is raised, enabling Fannie Mae to buy more mortgages, Bloomberg reports.

Portfolio.com’s Felix Salmon is critical of Fannie Mae, but observes that “As long as the capital markets are willing to inject new capital into the GSEs, that means the federal government doesn’t have to.”

As home prices continue their free fall and banks shy away from lending, Washington officials have increasingly relied on two giant mortgage companies — Fannie Mae and Freddie Mac — to keep the housing market afloat, the Times reports.

But with mortgage defaults and foreclosures rising, Bush administration officials, regulators and lawmakers are nervously asking whether these two companies, would-be saviors of the housing market, will soon need saving themselves.

The companies, which say fears that they might falter are baseless, have recently received broad new powers and billions of dollars of investing authority from the federal government. And as Wall Street all but abandons the mortgage business, Fannie Mae and Freddie Mac now overwhelmingly dominate it, handling more than 80 percent of all mortgages bought by investors in the first quarter of this year. That is more than double their market share in 2006.

The Times draws attention to concerns over changes in accounting that have helped boost the GSE’s numbers: “The regulator’s report also noted that Freddie used accounting choices that gave it an immediate $1 billion capital increase. While those and other tactics are technically permitted, the regulator said, they deserve scrutiny.

“Companies can make assumptions that cause very large differences in what they report,” Mr. Lockhart said in an interview. He has repeatedly said that the companies are making good progress and have fixed many of their problems. But at least one accounting choice, he said, “concerns us.”

Both Fannie and Fredddie have also recently changed their policies on delinquent loans, which they previously recorded as impaired when borrowers were 120 days late. Now, some overdue loans can go two years before the companies record a loss, the Times says.

Some analysts are bullish on Fannie Mae, or at least they were prior to today’s announcements. On April 8, Lehman Brothers upgraded the company to Overweight from Evenweight, “because their political standing, ability to deploy capital, and high return investment options have all improved significantly in recent weeks, which we believe should cause the shares to gradually return to historical valuations of 2x-3x book once credit costs peak in ‘09.”

Morgan Stanley on April 25 initiated a small long position in Fannie Mae:

Our thesis is that the market is missing several revenue growth drivers that will help generate above-consensus EPS in 2009.

Both Standard & Poor’s and Fitch today put some of Fannie’s ratings on Negative watch, but both affirmed its senior rating. S&P gave similar treatment to Freddie.

Moody’s downgraded the outlook on Fannie’s financial strength rating to negative while affirming all other debt ratings.