US Gov’t Considers Fannie/Freddie Takeover With No Debt Guaranty!

Posted on July 11th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

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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Mr Mortgage: Mortgage Modifications Part 2 – Being Forward Thinking

49 Responses to “US Gov’t Considers Fannie/Freddie Takeover With No Debt Guaranty!”

  1. It is amazing that a lender discontinues option ARMS at this stage in the crisis. Who is backing their paper other than us?

  2. […] Open question: Is the U.S. Government too big to fail? [Bloomberg][Mr. Mortgage] […]

  3. So…. does this mean the Government ISN’T going to make Freddie and Fannie take on more JUMBO loans to help out the mortgage mess?? No wonder Fannie and Freddie fought that one. Sure, let the government take over these GSEs so they can add the jumbo loans onto the books too. They’re so good at running things as long as WE’RE the backstop for the Government!

  4. One thing to understand is that if the government does not back up the Agency MBS then the interest rates that investors require to invest in MBS will shoot up, perhaps way up. This means mortgage rates shoot up which will knock the housing market even farther down. The widening of Agency MBS spreads over the last year has pushed conforming mortgage rates around 80-100 basis points higher than where they would have otherwise been. Prior to July 2007, the 30 Year Mortgage Rate was a 150 basis points or less over a 10 year Treasury. Now that spread is close to 250 basis points.

  5. Fannie and Freddie are supposed to be are last hope in propping the housing market. These two are off by approximately 50% in less than a week. Even former St. Louis Federal Reserve President William Poole said that these two are insolvent.

    Their combined market cap is $18.05 billion and they have $5 trillion in mortgage debt? Now that is what I call maximum leverage!

  6. No. The US government is not to big to fail. Where is the IMF ? The IMF should impose a violent structural adjustment plan to Washington. This country will finish like the USSR. Hey the rest of the world is damn stupid. This country is fundementally bankrupted. Fannie and Freddie were nice little gimmicks to hide the real state of affairs. Anyways it’s good news. Maybe the foreign investors will, from now on ask much much higher interest rates on US treasuries and stop the monetary madness goin on.

  7. Right Dr – this is a black swan of epic propertions especially if they do not back the agency debt. But how can they…$5 TT!

  8. You nailed it Ravi. Rates will shoot up, which is already happening gradually.

    You are right about spreads. Back in 2003-2006 real 30-yr fixed rates were much closer to UST than today. And today’s loans are arguably much better vintage. This is the free market working though.

    I agree that agency debt must be liquid in order for the housing market to have any chance, but for all intents and purposes they have never had a guaranty in the first place and the market is liquid today.

  9. Fannie and Freddie have around $5 Trillion in mortgage guarantees. They have around $1.5 Trillion of agency debt which primarily funds their retained portfolio of mostly their own MBS and unfortunately some Alt A and Subprime MBS.

    A worst case on the $5 Trillion IMO is 10% losses. Most of these mortgages are not in bubble markets and a lot are to people with good credit and equity in their homes. The GSEs were lemmings and did stretch on FICO Scores and LTV over the last few years but their portfolio is still well better than an Alt A or Subprime portfolio. A reasonable question here is why not let the MBS investors take 5%-10% losses if it comes to that. Even on a bond investment that is hardly a catastrophic loss. Unfortunately I think the initial reaction to that policy would be market panic and mortgage rate spike, but the reality to each MBS investor is a not nearly as bad as throwing around the phrases $5 Trillion and insolvency makes it sound.

    In terms of the $1.5 Trillion in agency debt, the Feds would really have to back that in a receivorship scenario for a while or face higher losses and panic then necessary. If they do not back it, the GSEs would have to firesale the MBS that this debt funds and possibly come up several hundred billion short. Your average money market fund holds a lot of this agency debt. The better move IMO would be unwind the portfolio over a period of time.

    My guess still is that the Feds will back the Agency MBS guarantee if it comes to that. In a worst case scenario the cost will be similar to the S&L bailout in today’s dollars. But it should be less than that, I think the 10% loss estimate is high and the GSEs have around $100B in capital and profitable current business to partially offset the losses. Of course I also think it is a reasonable possibility the taxpayer may have to shore up the FDIC when WAMU and company become insolvent.

  10. I agree – perhaps sllit the losses with the MBS holders at the very most. The MBS holders are suppose to be the smartest guys in the room. They knew their risks.

    They did talk about unwinding the portfolio over a period of time but when things like this happen, panic still ensues.

    Haha – I forgot about other banks out there such as WM, WB etc that will require some of the same backing.

    Thanks for the comments. Is this Ravi, Ravi?

  11. One more question RAVI, what IF defaults rates accross their portfolio turn out to be larger than we think. I am under the assumption that Fannie alone has about $300bb in subprime and $300bb in alt-a. I could be wrong but those numbers are in my head.

    Also consider that their prime is not really prime in many cases (see below) and with values down so much across the nation and home equity loans so previlent in the past 3 years, many dont have the equity they used to.

    I added this to the original post…

    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.

  12. Come on MAN, throwing out those big old Trillion Dollar numbers again. Does not sound like the words of a 20 year vet. So every FNMA/FHLMC loan is going to default?

    What are the current default rates? Last I heard was around 3%. Let’s apply a little reality please.

    Good post by Ravi, $100 to $200 Billion to sure up this mess. Lot of money for sure, catastrophic meltdown, I think not.

    Although the asset values were smaller, there were well over 1000 Savings and Loans that collapsed. No severence, no notice, no nothing. I was one that received this, then became one that dished it out. IndyMac people whining about $20K seerences should be ashamed.

    And by the way, the US government absolutely can not collapse. It would bring the whole world down followed by a global war, which we would win handily.

  13. Not to Big to Fail?

    They keep talking about a taxpayer bailouts.. What happens when the taxpayers pockets are empty?
    One of these days,they(the government) are going to reach deep into his pocket and their is going to be nothing there!
    Then what?I know I am tired and my own pockets are pretty empty..

  14. no one wins in a war … humanity loses . since the US started the mess, you can be sure russia & china would team up to take us down .. a catastrophy you would likely not survive in, so you get real

  15. Guys, please, this catastophic meltdown BS is more worn out than a $2 whore.

    Phil Graham is at least partially correct in that a lot of the economy decrease is mentally driven. Gloom and Doom, Gloom and Doom, Gloom and Doom is all we seem to hear.

    CA, FL and a few other states are in sad shape for sure. End in sight, I think not, more pain to come for sure. The rest of the country is having soem rocky times at worst.

    Adjust your lifestyle, get in to a different industry, or move. The whining will get you no where.

    No if the marxist Obama actually gets elected and taxes us into submission, you might hear me singing a different tune. I hold on with optimistic hope that the people of the US are not that stupid.

  16. Pssst….MM85: It’s not the government that will collapse – ‘It’s the Economy, Stupid!’ Be assured that you will collapse with it! 😉 The government will have its hands full, trying to placate (and incarcerate) millions of VERY pissed off Americans, looking for the criminals – and bearing arms, as guaranteed by the Constitution. And you know how Americans are: They tend to shoot first and ask questions later! The government has been contemplating for some time how to deal with millions of armed Americans, laying siege to DC – the District of Criminals. You don’t wannabe in their moccasins!

  17. Most of the comments here sound like a bunch of surgeons, discussing how long a patient with terminal cancer has to live. Is it months – is it weeks – or is it DAYS? I’ll take a 90-day PUT option that the patient will die. Why? Because that’s what the treatment anticipated. Meanwhile, Iran is waiting in the wings, firing test missiles (AFTER the Israeli war games!).

    Mazel Tov, America!

  18. As horrible as it may sound, I almost hope those mid evil lunatics to get a missle off to Israel.

    After we make the Middle East in to a bowl of glass, perhaps the islamofacists and panty waste liberal trash in this country will get it.

  19. Can anyone guess who the ‘Halliburton-built’ gulags are for? Do THEM know something but are not telling?

  20. The action in gold bears some watching – today and in the near future. When will it hit $1,000 – then $2,500 – then $5,000 – then $12,500!?

    What’s that you say: “Not so fast”?

  21. Buy gold and buy silver and take physical delivery. Today the government of Spain tried to sell 10 year bonds and was forced to remove the offering. Spain will the first to declare bankruptcy. Ant the ECB will have to lower its interest exactly like the USA. As for the USA, expect massive monetization of the debt. These damn psychopaths called politicians won’t admit it. They have no choice.

  22. Is Lehman going bankrupt ? The shares are going like Fannie and Freddie way. Another nationalization ? The word is “massive monetization of the debt.”

  23. It’s either crater the currency or crater the banking system. I know which one they will pick. Agency paper is spread everywhere. They will back it.

  24. Bah, its overblown all this fannie and freddie stuff. 🙂

    http://www.thestreet.com/story/10425923/1/fannie-freddie-media-panic-overblown.html

  25. Ravi: “why not let the MBS investors take 5%-10% losses if it comes to that”

    Are the funds from MBS investors invested at a 1:1 ratio? Aren’t the banks are allowed to lend out up to 10:1 of the deposits? A leveraged 10% loss would be a 100% non-leveraged loss in that case.

    Please correct me so I can understand.

  26. Marc Authier: The longs on the LEH Yahoo board are blaming the rumors from shorts for the fall in share price. I think it is 10Q myself.

  27. FYI – here you go folks!

    SAN FRANCISCO (MarketWatch) — U.S. banking regulators said Friday they have closed IndyMac Banorp Inc., the biggest retail bank to succumb to the ongoing U.S. subprime mortgage crisis. The Federal Deposit Insurance Corp. said in a statement it will take over operations of IndyMac which had total assets of $33.01 billion and total deposits of $19.06 billion as of March 31.

  28. IMB loss to the FDIC is staggering!!

    Wow, I wonder how bad FED and DSL’s assets really are compared to IMB.

    Go to the FDIC website and check out the details. The book value of IMB assets were $32 billion and the book value of the deposits was $29 billion. I assume this implies that book equity is roughly $3 billion.

    If this is the case then how can the preliminary estimated loss to the FDIC is between $4 to $8 billion? This would imply the FDIC values the $32 billion book value to have an asset value of $21 to $25 billion. That means the real value of IMB book assets of $32 billion is truly worth anywhere between 25 percent and 33 percent less thatn what IMB and Perry said they were worth. Of course some of the $32 billion assets were treauries, cash, and items worth par, therefore the real loss to their loan portfolio is even greater.

    That is incredible. This means that DSL and FED is dead also.

    Incredible.

  29. Double the size of the public debt? NYTimes is spouting silly talk and Bloomberg and MrMortgage are repeating it.

    $5T of loan guarantees does not meant $5T of debt, any more than me co-signing a loan for my nephew for $250K (for a 20% down home purchase) makes me $250K in debt.

  30. any more than me co-signing a loan for my nephew for $250K (for a 20% down home purchase) makes me $250K in debt.
    If something happens to your nephew and he can’t pay who is responsible?

  31. Mike T, Answer: Me. But with 20% down, and a home the bank can foreclose on the odds of me being indebted to the bank by much is slim, and of becoming in debt to the bank by $250K virtually nonexistent unless some uninsured catastrophe were to strike.

  32. Know why ?

    Most of the debt was bought by the Popular Republic of China !!!! This is really funny. Sorry I must add here, sorry again, stupid foreign investors from China. What were you thinking anyways dear China ? Didn’t want to add this comment, but I had no choice in these circumstances. It’s perfectly logic that the US government refuses to offer a guaranty to a foreign government. China knew the risks it was taking. Sorry China. Next time dont’t fuel bubbles with the FED.

  33. PRC may be the largest single holder of agency paper but theirs is only a small fraction. The stuff is like a proxy for treasuries and is truly everywhere. I would wager that US-based institutions hold more than 1/2 of the outstanding notes. If spreads continue to widen, there will be very significant distress in the shadow banking world.

  34. But who operates in the shadow banking world ? Love this expression. “Only the shadow knows.” US capitalism was supposed to be so transparent. Yeah sure. Shadow banking for shadowy chacarters from Columbia or Indonesia or Zimbabwe. I get the picture. Anyways it’s a good thing that the government refuses to extend guarantees to all. Talk about moral risk.

  35. Moral hazard for an immoral paper bubble.

  36. Poor Mr. Mortgage,

    He has the Dataquick foreclosure data, IndyMac, F&F, Lehman, and who knows what else breaking. I think he is going to go into total overload by the end of next week.

  37. All of the talk about nationalizing this or that … about forcing bondholders to take losses of this or that … is making my head hurt.

    Where is the sanctity of property rights? Where is the sanctity of the contract, that is inherent in the rule of law?

    If we allow ourselves to throw out the basic foundations of democratic capitalism, then we will have lost much more than some tax dollars.

    One wise man once observed …. Democracy simply must be about more than 2 men voting to confiscate the property of the 3rd man.

    Payment preferences in bankruptcy are long established, and the code is clear. Those who entered into contracts are entitled to live with the risks they chose.

    So my vote is to either put these beasts into regulatory receivership the way the system envisioned — or — put some cash in if they want to prop them up — or — just go ahead and explicitly guarantee all or some clear portion of the obligations. But don’t screw around with the contracts knowing parties entered into.

    My $0.02

  38. Look up when walking under high buildings.

  39. I don’t agree with a bailout of GSE bondholders but remain quite certain it will happen. The default risk is comparable to that of treasuries themselves. Imagine if all these notes were repriced 10%, 20%, 30% below face. It would crush the banking system. The path of least resistance is always the currency. So, this is how it will go.

  40. Wow – wow wow wow

  41. too funny that Sen. Charles Schumer is being blamed for bringing down Indy.. I mean come on, like a letter can bring down a company.. kinda like short sellers taking down Bear.. what a joke! How about admitting that your bank got greedy?

    Like the old saying goes.. you can make money in the market if you are a bull, or a bear – but if you are a pig, you will always get slaughtered..

  42. Michael, I think your right on many fronts regarding Indymac, the senator’s comments while Indymac was on the razor’s edge was not helpful, and probably was the last nail in the coffin. Look at the deposit/withdrawal flows since Shumer’s letter went public.

  43. Mr. Mortgage — I have a question about Freddie Mac loan putbacks if you or anyone else can answer. Looking up foreclosures in my neighborhood at the county deed website, I see that two of them were originated in the summer of 2007 by Washington Mutual, then foreclosed with a Sheriff’s Deed in early 2008 by Federal Home Loan Mortgage Corp (Freddie Mac). Presumably the loans were sold/assigned to Freddie Mac in the interim, although I don’t see any Assignment deeds. They were both pretty blatant fraud cases with hugely inflated appraisals after a quick flip, and then Early Payment Defaults (probably First Payment Defaults), both foreclosing within 7-8 months.

    My question is, doesn’t Freddie Mac have some sort of loan putback clause, in which case they can put back Early Payment Default loans to the originator? If they did, wouldn’t the deeds/REO also go back to the originator (Washington Mutual in this case), or not necessarily?

    One of the homes is still for sale as REO on the Freddie Mac website if you’re curious, search for the 48214 zip code:

    http://homesteps.com/hm01_1featuresearch.htm

    It’s listed for $47,500, the original WaMu mortgage was for $380,000 (for a current LTV of 800%). The other one was on the site but apparently already sold for $20,500, the original WaMu mortgage was $340,000 (for a current LTV of 1658%). I’m just wondering which party is going to eat the huge loss on these loans.

  44. I think the most likely scenario for the GSE’s will parallel the most common route taken according to bankruptcy law. It’s just the lay of the land.

    To wit, the stockholders will get virtually nothing and the bondholders will receive full paymenbt. This is consistent with the flood of buying in GSE debt on Friday while the stocks were sold off dramatically.

    Tony

  45. IS Ravi, professor Ravi?

  46. Mr Mortgage,

    I read there are currently somewhere between 90-200 banks on the FDIC failure “watch list”, but heard that in the 1980’s there were about 200 bank failures per year. (thus by comparison we suposedly shouldn’t be worried)

    I have the following questions:

    1. How many U.S. banks are there today vs 1980’s? (My guess is much less today than in the eighties due to consolidation)

    2. What is the average bank size today vs. banks in 1980’s? (would like to see inflation adjusted and non-inflation adjusted. My guess is the banks today are much larger on average than in the 80’s)

    3. I understand the FDIC has about $53B reserves to bail out the failed banks. Has the FDIC reserve requirement been adjusted upward along with inflation over the years? (My guess is no)

    — my hypothesis is that 80+ bank failures today would be much more significant than 200 failures in the 80’s. Also, due to inflation I suspect the FDIC’s effective bailout capability is probably 1/2 of what it was in the 80’s. Can’t wait to hear your response.

    Mahalo from Hawaii – Eric

  47. “Has anyone seen my world savings glut ?” Ben Bernanké.

  48. This post by Brad Setser makes it clear why with respect to global financial markets any assistance to FNM and/or FRE without guaranteeing their debt is practically unthinkable.

  49. Short US treasury bonds. advise Jim Rogers. It’s a way of insuring that Congress will not do something even more stupid. They can you know, and they will.

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