This is somewhat expected, but not when it comes to NOT backing up their paper (see below in red).
Most assume that if the agencies fail, the Gov’t would backstop their $5 trillion in guarantees, which is why the agency market has held together fairly well through all of this. However, this may not be the case.
As you know in recent days, Agency spreads have widened considerably on speculation that Fannie and Freddie are in serious trouble and would not be able back up said guarantees. Now it is questionable whether the Gov’t would back the paper in the event of a take over.
This could spell big trouble for the agency debt world.
Most think that the Gov’t currently backs agency paper but that is not the case. The Treasury backs $2.25 billion a piece for Fannie and Freddie. That is less than 1/10th of 1% of the total outstanding guarantees.
Agency security investors should be savvy enough to know that the mortgage backed debt issued by the agencies are backed by the full faith and credit of the agencies and very little is backed by the Gov’t. Why should there be a bailout of investors in the agency arena on taxpayers dollars? You mean to tell me they didn’t know the risks in investing in real estate backed assets?
There is also a misconception that Fannie and Freddie’s loans are all ‘prime’ and have little chance of default. Take it from this 20-yr mortgage veteran, nothing could be further from the truth. The agencies have hundreds of billions of the same Alt-A and subprime loans that are defaulting to such a great degree everywhere else. Fannie and Freddie’s approval systems, Desktop Underwriter (DU) and Loan Prospector (LP) respectively, used to be so flawed and relied so heavily on credit scores for an approval during the bubble years, that until recently that most full-doc loans with decent credit scores and LTV’s at 80% or below were allowed to pass without much income or asset documentation at all. They were closer to stated income loans than full doc. Yet, they are still considered ‘Prime’ in most cases. In addition, during the bubble years many non-cash out loans and purchases, were offered an ‘appraisal waiver’ if their systems like the profile of the borrower and property.
Agency defaults are surgingas values are dropping and I can promise you in the future their default rates will be blown out as well. Remember, subprime loans default primarily due to rate resets and Prime and Alt-A loans default primarily due of negative equity. That is of course, other than the Pay Option ARM, which defaults because that is what it was designed to do if values do not constantly rise. A $5 trillion guaranty, although not all loans will default, is too much to ask of the tax payers in this real estate market and to guaranty loans where default acceleration rates are surging.
Remember, there is no guaranty today and agecy debt is liquid. Why should a guaranty be added that does not exist today? This story is only getting started I am afraid. -Best, Mr Mortgage
U.S. Considers Taking Over Fannie Mae, Freddie Mac, NYT Reports
By Joseph Galante July 10 (Bloomberg) —
“U.S. officials are considering plans to take over one or both of the nation’s largest mortgage finance companies, Fannie Mae and Freddie Mac, if they continue to deteriorate, the New York Times reported.
The government is discussing placing them in a conservatorship, under which the companies’ shares would be worth little or nothing and losses on mortgage holdings would be covered by taxpayers, the Times said, citing unidentified officials briefed on the matter. Their shares are plunging and their borrowing costs are rising as investors worry the companies will suffer losses larger than the $11 billion they have lost in recent months, the Times said.
The Bush administration is also considering offering an explicit government guarantee on the $5 trillion debt owned or guaranteed by the companies, the Times said.
Such an option is less likely because it would double the public debt, the newspaper said.
Still, Fannie and Freddie aren’t considered to be in a crisis, and no action is imminent, the officials told the Times.”
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