Washington Business Journal

Housing law short on answers for Fannie, Freddie

by Bryant Ruiz Switzky Staff Reporter
August 1, 2008

Spiraling stock losses. A government bailout. A new regulator. These are the highlights in what is sure to go down as one of the most tumultuous months in the history of mortgage giants Fannie Mae and Freddie Mac.

But on the heels of changes signed into law July 30, it’s unclear what the new rules will mean for the future of District-based Fannie Mae and McLean-based Freddie Mac.

The act makes explicit the government’s backing of Fannie and Freddie, which had merely been implied up until now. It also creates the Federal Housing Finance Authority, a new regulator for the government-sponsored enterprises, or GSEs. The explicit financial backing expires at the end of 2009, though it’s not clear how much impact it will have on Fannie and Freddie’s ability to lure investors.

Historically, the GSEs have been able to raise money easily because investors interpreted the implicit backing as making its bonds pretty much as safe as Treasury bonds, but with higher yields. Will an explicit backing make them any more appealing?

“I don’t think it’ll have much effect,” said Robert Losey, professor at American University’s Kogod School of Business. “Most people viewed the implicit backing as almost as good as the explicit backing.”

While selling bonds might not be a problem, investing the proceeds could be, said Gerald Hanweck, chair of the finance department at George Mason University School of Management. “If no one is buying homes, then they can raise all the money in the world and it won’t do anything to increase liquidity in the housing market.”

The Treasury’s backing of Fannie and Freddie is temporary, but the new regulator is here to stay. If the Federal Housing Finance Authority shortens the leash on the GSEs, it could have broad effects. One likely move: requiring the companies to hold more capital.

“Whether it’ll be a big move in the next year or a more gradual move is hard to predict,” Losey said. “But there will be pressure on the regulator to do that.”

Fannie and Freddie’s capital requirements have been much lower than that of banks, giving them proportionately less cushion to absorb losses. While raising their capital levels would calm investors’ nerves, it also would constrain growth at the firms, Losey said.

The regulator also will be under pressure to look more closely at Fannie and Freddie’s portfolios. As home prices continue to fall, the regulatory scrutiny could make the GSEs more likely to mark down the mortgages in their portfolios to fair market values — which would appear as losses, Losey said.

Hanweck isn’t as confident about the regulatory changes. “Their old regulator had a lot of power to change things, and didn’t. I don’t see that a new regulator is going to do it either. These are powerful companies with lobbying groups that work the regulator directly — and work the Congress that oversees the regulator. I don’t see that changing,” he said.

For its part, Freddie spokesman Douglas Duvall said the company “looks forward to playing a constructive role as the process of carrying out the legislation turns to rule writing.”

While the new law made some important changes, it still leaves many unanswered questions about Fannie and Freddie, said Stephen Ryan, head of the government strategies group at McDermott Will & Emery.

“It’s untenable to have an incomplete answer to the question: What is the relationship between the GSEs and the government?” he said. “I don’t think this bill answers that. It was just a Band-Aid over the implicit guarantee.”

He predicts that further debate about this issue will begin almost immediately and that Congress could further define the GSEs’ relationships with the government next year.

Many have called for Fannie and Freddie to become either fully private or fully public institutions, but Ryan doesn’t think it’ll happen. “They will always be hybrids, just more clearly defined hybrids,” he said.