Fannie, Freddie Debate Not Hurting Mortgage Rates

By Deborah Levine

The increasingly public debate over what the government will eventually do with mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), taken over last fall, leaves the mortgage market still waiting for a decided resolution, analyst said Thursday.

The Obama administration is considering a variety of options to overhaul mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), including folding the companies into a new federal government entity, the Washington Post reported Wednesday.

One option is to split the companies and putting their troubled assets in a new federally backed corporation, and possibly let to more viable portion of the company resume being shareholder-owned.

The important but unclear aspect is whether the entities, in any form, continue to carry the government's implicit support of their debt to keep their borrowing costs low. The so-called government sponsored entities sell their own debt to finance purchases of mortgage-backed securities, which are bundles of individual mortgages. Their ability to finance those purchases at a low cost enable them to accept mortgages with lower rates, which helps homeowners.

"As long as the government guarantees are there, the products will trade as they do," at rates far below what fully private companies have to pay, said Kevin Giddis, managing director of fixed income for Morgan Keegan & Co. "Any change would more than likely have a negative impact on the housing market."

Mortgage rates have risen over recent months as the economy appears to be improving, pushing up yields on Treasurys, which are the benchmark for a broad array of securities including mortgage debt. The rate on a 30-year fixed rate mortgage rose to 5.65% in the latest week, according to Bankrate.com. They fell to a low around 4.85% in the April.

More likely than such a "good bank/bad bank" arrangement for Fannie and Freddie, the firms may be structured like a public utility, said bond strategists at RBC Capital markets.

"The firms would be even more highly regulated than they are today, with products and pricing approved by a government board, commission or agency," said Ira Jersey, head of U.S. interest-rate strategy at RBC. "Assuming adequate capital ratios were kept, the GSEs would be allowed to pay out a significant amount of profits as common share dividends."

But in any case, the amount of debt held by the entities is also likely to be "dramatically" smaller, he said. The entities have been instructed to reduce the amount of debt they hold - currently near half of all outstanding home loans.

In all likelihood, the agencies will probably look rather different than they were, said Matthew Mac Donald, a bond portfolio manager at DWS Investments.

The firms, one which grew out of the Great Depression, will go back to their more traditional role of facilitating a basic social goal: extending mortgages so more Americans can own homes. Their basic role was standardizing underwriting rules and pooling loans and relieving some of the credit risk for investors interested in owning mortgages.

"The uncertainly isn't rattling the market at all," he said. "It's a healthy discussion as long as the government doesn't indicate it may pull support for existing programs and securities."

Fannie and Freddie have long been strange hybrids of government and private institutions and may, at least initially, end up closer to the government end of that spectrum because of lack of confidence in ratings for securitizations, MacDonald said.

Of all the possible outcomes, if they government chooses to make the entities fully private, "surely rates would increase," said Jeana Curro, a mortgage strategist at UBS Securities. "If they lose their implicit government guarantee, investors would need increased compensation."

Investors in mortgage-backed debt currently demand yields about 0.90 percentage points above Treasurys to compensate for the different credit structure, analysts said. Spreads between corporate bonds and Treasurys are almost three times that.

-Deborah Levine; 415-439-6400; [e-mail]