UPDATE: Regulator: Fannie, Freddie Vulnerable To Delinquencies

Fannie Mae (FNM) and Freddie Mac (FRE) remain vulnerable to mounting home mortgage delinquencies as well as the troubled multifamily market, the companies' regulator testified at a U.S. Senate hearing Thursday.

"While a few positive signs of recovery in housing have begun to emerge, we remain concerned and recognize the risk associated with increasing numbers of seriously delinquent loans," Federal Housing Finance Agency Acting Director Edward J. DeMarco told the Senate Banking Committee in prepared remarks.

Government-sponsored enterprises Fannie and Freddie have racked up a combined $165 billion in losses over the past eight quarters, due to soaring mortgage defaults. The rate of seriously delinquent mortgages at Fannie and Freddie is 4.2% and 3.1%, respectively, according to DeMarco's testimony.

"These rates are disturbing both in their magnitude and the fact that they continue to increase," he said.

Meanwhile, Fannie's and Freddie's combined share of the multifamily or apartment market has swelled, jumping to 84% last year from 34% in 2006, according to the testimony. The multifamily sector is experiencing the highest vacancy rates since records began in the 1950s.

The companies also remain vulnerable to losing senior staff as the economy recovers, DeMarco said. In the past year, Fannie and Freddie have both undergone substantial turnover at the highest levels, and several key positions below the executive levels remain vacant.

"As we see improvements in the economy, opportunities for employees and officers to seek other employment will increase, adding to the current retention challenge," DeMarco said.

The hearing is one of the first signs that lawmakers are turning their attention to Fannie and Freddie, which were seized by the government over a year ago amid soaring mortgage defaults.

In its plan to revamp financial industry regulation, the Obama administration was silent on the issue of the government's role in the housing market. It says it will unveil a proposal for the future of Fannie and Freddie when it releases its 2011 budget in February.

Since Fannie and Freddie were thrown into the conservatorship of their regulator, they have been ordered to take on various initiatives to prop up the housing market. Treasury has also pumped $96 billion into the companies to keep them solvent under agreements that give Treasury a preferred stake in the firms.

Treasury's agreements and the many initiatives the companies have undertaken "could increase the costs and challenges of associated with transitioning to new structures," William B. Shear, Government Accountability Office director of Financial Markets and Community Investment, said in prepared remarks. He said it was impossible to predict the effects, but they could be substantial.

Peter Wallison, a financial industry expert at the American Enterprise Institute, said that proposals to revamp financial industry rules could have unintended consequences for the mortgage market.

He said proposals to require banks to hold more capital and to retain a portion of the credit risk of any mortgages they sell to investors wouldn't likely apply to Fannie and Freddie while they remain in conservatorship. That would give the enterprises a huge cost advantage that would allow them to expand their market share, he said.

"If this happens they will likely assume the credit risk of the entire mortgage system," Wallison said.

In his remarks, Shear reiterated many of the conclusions of a recent GAP report on options for restructuring Fannie and Freddie.

The companies' mixed record on achieving their housing mission and their recent near collapse last fall reinforces "the need for Congress and the executive branch to fundamentally reevaluate the enterprises' roles, structures, and business activities in mortgage finance," he argued.

- By Jessica Holzer, Dow Jones Newswires; 202-862-9228; [e-mail]