Monday, December 28, 2009

Fannie and Freddie Get a Blank Taxpayer Check - Alpha

A queer holiday update from Hussman here.

It was about a sneaky Christmas eve decision the US Treasury made regarding the largest buyer of mortgages (after the Fed) - and as the WSJ notes, the timing wasn't a coincidence.

Basically, the Fed and Treasury have kept the US property markets alive (residential, commercial, etc.). The Fed bought $1,040bn in agency and MBS in 2009 (more than a trillion dollars!), and $300bn in US Treasuries (monetized debt, where the Fed printed money). See here to compare Dec. 23, 2009 to Dec. 24, 2008 (the change):

The US Treasury bought $220bn through Fannie and Freddie. Both are more insolvent today than they were a year ago (the value of their assets have decreased even further, while their liabilities, held by bond funds and foreign central banks, have stayed constant without any defaults or haircuts).

For one example of how all property investors are dependent on Fannie/Freddie, here's what the largest apartment REIT company (EQR) in the US says about their dependence:
"The continued credit crisis has negatively impacted the availability and pricing of debt capital. During this time, the multifamily residential sector has benefited from the continued liquidity provided by Fannie Mae and Freddie Mac. A vast majority of the properties we sold in 2008 and 2009 were financed for the purchaser by one of these agencies. Furthermore, Fannie Mae and Freddie Mac provided us with approximately $1.6 billion of secured mortgage financing in 2008 and $500.0 million thus far in 2009 at attractive rates when compared to other sources of credit. Should these agencies discontinue providing liquidity to our sector, have their mandates changed or reduced or be disbanded or reorganized by the government, it would significantly reduce our access to debt capital and/or increase borrowing costs and would significantly reduce our sales of assets."

Remember, that the collapse of Fannie and Freddie is what caused the economic "equilibrium shift" from a mild recession to a depression (their death spooked investors, which then pushed the riskiest banks and insurance companies, like Lehman and AIG, to fail).

Here's what I find interesting from the Treasury release:
1) Does the following mean that the US Treasury will no longer support the MBS property market bubble through Fannie and Freddie buying MBS?
"Program Wind Downs
The program that Treasury established under HERA to support the mortgage market by purchasing Government-Sponsored Enterprise (GSE) -guaranteed mortgage-backed securities (MBS) will end on December 31, 2009. By the conclusion of its MBS purchase program, Treasury anticipates that it will have purchased approximately $220 billion of securities across a range of maturities.
The short-term credit facility that Treasury established under HERA for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks will terminate on December 31, 2009. This credit facility was designed to provide a backstop source of liquidity and has not been used. "

2) Does the release mean the US Treasury will try to shrink Fannie and Freddie's asset base, meaning that real estate investors won't be able to get mortgages through them anymore (in some long-run scenario)? Or that it won't for three more years, which is the out that allows the Fannie/Freddie mortgage support (i.e. shell/monetization game) to continue? How "committed to principle" is the Treasury? Remember, that the $110bn that Treasury has given so far gets multiplied many times over, since it's an equity base that Fannie/Freddie lend off of. If a cap is $200bn and the multiplier is 10x, this is opening the door toward a further $2 trillion expansion of Fannie/Freddie's lending, where the $200 bn in front is loss-equity capital that taxpayers take (to bail out stupid homebuyers and debt issuers). This is a massive bailout... yet again.
"Amendments to Terms of Preferred Stock Purchase Agreements
At the time the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship in September 2008, Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth. Treasury is now amending the PSPAs to allow the cap on Treasury's funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years. At the conclusion of the three year period, the remaining commitment will then be fully available to be drawn per the terms of the agreements.
Neither firm is near the $200 billion per institution limit established under the PSPAs. Total funding provided under these agreements through the third quarter has been $51 billion to Freddie Mac and $60 billion to Fannie Mae. The amendments to these agreements announced today should leave no uncertainty about the Treasury's commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.
The PSPAs also cap the size of the retained mortgage portfolios and require that the portfolios are reduced over time. Treasury is also amending the PSPAs to provide Fannie Mae and Freddie Mac with some additional flexibility to meet the requirement to reduce their portfolios. The portfolio reduction requirement for 2010 and after will be applied to the maximum allowable size of the portfolios – or $900 billion per institution – rather than the actual size of the portfolio at the end of 2009.
Treasury remains committed to the principle of reducing the retained portfolios. To meet this goal, Treasury does not expect Fannie Mae and Freddie Mac to be active buyers to increase the size of their retained mortgage portfolios, but neither is it expected that active selling will be necessary to meet the required targets. FHFA will continue to monitor and oversee the retained portfolio activities in a manner consistent with the FHFA's responsibility as conservator and the requirements of the PSPAs."

I'm waiting for Hussman's views on how to interpret this cryptic release. It just looked like the US govt. is writing its largest loss-driven blank check (after AIG) and no one is paying attention (of course, the Citigroup bailout/guarantees and the Fed's low-quality asset purchases will come home too).

UPDATE: Here are the interesting explanations from Hussman, Tim Duy's Fedwatch, and Paul Krugman at Princeton blogging for the NY Times.

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