Investors might recall that at the time the agencies were ushered into conservatorship, the plan was to shrink the balance sheets of these mortgage goliaths to reasonable levels and transfer some of the mortgage business back to the private sector. Since that time, we have seen the balance sheets of these giants continue to grow and encompass more of the total mortgage market in the United States. On Friday (8/17), the Treasury put its foot down and changed the terms of the bailout. Specifically, they changed the definition of dividend and the agencies portfolio reduction.
From the Treasury's release:
Accelerated Wind Down of the Retained Mortgage Investment Portfolios at Fannie Mae and Freddie Mac: The agreements require an accelerated reduction of Fannie Mae and Freddie Mac's investment portfolios. Those portfolios will now be wound down at an annual rate of 15 percent - an increase from the 10 percent annual reduction required in the previous agreements. As a result of this change, the GSEs' investment portfolios must be reduced to the $250 billion target set in the previous agreements four years earlier than previously scheduled.
Full Income Sweep of All Future Fannie Mae and Freddie Mac Earnings to Benefit Taxpayers for Their Investment: The agreements will replace the 10 percent dividend payments made to Treasury on its preferred stock investments in Fannie Mae and Freddie Mac with a quarterly sweep of every dollar of profit that each firm earns going forward.
The change to the agreements comes nearly a year after the announced initiatives, but it is here. The question now becomes, over the next four years will the private sector underwrite more loans and, importantly, without the agencies what will the new mortgage conduit look like?
One of the benefits of the GSEs was the standardization of mortgage product (in theory) and the ability to use this standardization to transfer the risk to investors. I do not expect that banks will keep this risk on their balance sheets (too much and capital intensive), so standards will have to be set in order to make "non-agency" mortgages more saleable. Assuming the arbitrage (funding versus lending) is still somewhat attractive, I would expect the mortgage REITs to be more involved and continue to be a means of investing in mortgages and mortgage backed securities.