Rob Zimmer
Dont believe doom and gloom on Fannie Freddie


This year there’s been some chatter that investors are shying away from mortgage-backed securities sold by Fannie Mae and Freddie Mac.

The talk has cropped up because some alleged a deterioration in the bids for Fannie/Freddie MBS. But the bids for these instruments have not widened, relatively, from risk-free Treasuries.

So what’s going on here?

For one, the largest MBS investors desire the benefit of a massive government guarantee behind all such securities. And it’s to lobbyists’ benefit to argue that the government-sponsored enterprises would receive a ratings downgrade if they are released from conservatorship without action by Congress to grant them a new “explicit guarantee.”

Yet they already have a backstop today which will outlive the conservatorships, and be paid for via a commitment fee already authorized in the preferred stock purchase agreements, thus making the guarantee explicit.

This backstop guarantee is 100x larger than the GSEs had between 1992 and the financial crisis — a period during which they maintained outstanding credit ratings. With more capital, the existing close relationship between the federal government and Fannie and Freddie, and housing‘s central role in the U.S. economy, and well-managed books, investors will remain assured.

Put a simpler way: in addition to the direct obligation (the backstops with about $250 billion capacity), the ratings agencies view all the agency housing GSEs (including the Federal Home Loan Banks) as a major contingent liability of the federal government, even as their obligations are not counted as direct government obligations (as in the case of Ginnie.)

The reality is, post-conservatorships, Fannie and Freddie will remain specialized Congressionally-chartered agencies, integral to the U.S. housing system, responsible for about 50% of those assets. They will remain linchpins, albeit with more capital, less leverage (no retained portfolios), and more risk-sharing. They will remain AAA so long as the U.S. itself remains so.

Some will argue that while Fannie and Freddie may retain a AAA rating, investors might nonetheless pull back some from MBS purchases. But they offer no historical or even modeled data for this claim.

It’s also true that making Fannie/Freddie MBS more attractive will make Ginnie MBS less attractive on the margins. Ginnie MBS have zero risk weight, an advantage for these instruments, but if Washington (it won’t, but for the sake of discussion) moves Fannie/Freddie MBS into the same zero risk weight category, the more liquid F/F MBS would attract more bids and the Ginnie MBS would attract marginally fewer bids.

In plain terms, Ginnie’s funding advantage relative to Fannie and Freddie would be eliminated. There’s a cost to that, especially for rural, veterans’, and moderate-income families, who would see higher mortgage rates.

Perhaps some in the MBS world thought days of easy money were potentially within reach. For a time, the narrative was that Congress would act here, that it had to in order for the conservatorships to end. Perhaps many thought Congress really would vote to create a brand new taxpayer backing of MBS in the near term.

A taxpayer backing of F/F MBS, later or concurrently expanded to all MBS, would make the entire U.S. mortgage market sovereign, as Ginnies are today. Gaining a taxpayer guarantee here would move non-Ginnie MBS capital risk weighting to zero (from 20%) and leverage ratio weighting for high-quality assets to zero (from 15%).

The trading market here would explode as MBS became easy money for asset managers and big bank balance sheets, turbocharged by these new risk-free securities.

As a blunt measure of the potential gains, for the sake of scale only, if the entire $5 trillion of GSE MBS were on the balance sheet of banks (they aren’t), and the risk weight went from 20% to zero, this would free up $1 trillion. Even if only half these assets were on bank balance sheets, $500 billion in freed-up money is still huge.

There’s no evidence linking pricing changes of Fannie/Freddie MBS to anticipated changes in the conservatorships. But one can expect lobbyists to continue to push this rich new subsidy, and one way to pressure U.S. policymakers is to create a buzz that GSEs moving on capital restoration plans and eventual release — as the current regulator states is required by law — leads to all hell breaking loose in U.S. mortgages markets and thus, economic activity in general.

One can’t blame the big finance lobby for desiring these riches; it’s certainly their right to try to gain it. It’s a staple of U.S .finance to try and gain markets via government backings.

But it’s another thing to lobby for this with pure speculation about ratings changes and markets pricing when there’s no data to back it.


Rob Zimmer

Rob Zimmer is principal at TVDC, a consulting firm in Washington DC.


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