Investor Uncertainty Surrounds GSE Debt as Frank Sounds Second Lien Alarm
House Financial Services Committee chairman Barney Frank (D-Mass.) on Friday morning told reporters that Fannie Mae (FNM) and Freddie Mac (FRE) bondholders should not expect federal backing of agency debt, indicating that the federal guarantee some have come to expect on their investments may not be so cut and dry. In addition to potentially destabilizing investor confidence for these structured products, his remarks arrived amid news of a letter from Frank urging the top four lenders to pursue "immediate steps to write down second mortgages." As HousingWire first reported, industry concern over second mortgages is mounting as "silent" second liens become a louder issue to bondholders of residential mortgage-backed securities (RMBS). Frank, in a call to forgive principal of second liens, said bank reluctance to write down the principal on these second liens is also hindering the modification of first liens. As negative equity grows, so does the consumer mentality of strategic default, according to Frank. Additionally, sources say Frank's comments spooked the investor community, especially in light of an indication that bond holders in government-sponsored enterprise (GSE) debt could be forced to take a "haircut." “Please don’t think this is federally guaranteed. I don’t think it is. I don’t think it should be. I don’t feel any obligation to bail you out,” he told Bloomberg. By mid-day he issued a statement clarifying that "Fannie and Freddie debt [does] not have the same legal standing as Treasury" debt. He also said he supports the Treasury standing "fully behind the terms" of its unlimited guarantee of agency maturing inside of 2012. Then, in a CNBC interview, Frank clarified that agency debt purchased prior to conservatorship of the agencies is different from debt purchased during conservatorship. This view, however, is "inconsistent" with the Treasury Department's unlimited support for senior and subordinated debt outstanding through 2012, according to commentary out from RBS Securities, a wholly owned subsidiary of the Royal Bank of Scotland (RBS). "Also, it would imply that an investor could sell debt purchase prior to conservatorship and turn around and buy it back in order to improve the standing with the government," said Margaret Kerins, an RBS managing director of agency strategy. The Treasury Department spoke up amid Frank's commentary Friday, reinforcing its support of Fannie Mae and Freddie Mac: "[T]here should be no uncertainty about Treasury's commitment to support Fannie Mae and Freddie Mac as they continue to play a vital role in the housing market during this crisis." Kerins noted agency spreads only widened slightly on the news and later retraced as domestic investors reacted to the Treasury's reiteration of its support, which itself confirmed government backing of the GSEs. "Our main worry centers on international clients who may avoid agency headline risk despite Treasury assurances coupled with the fact that there are only two Fed purchases left," Kerins said. Jim Vogel, a strategist at financial services provider FTN Financial, said in GSE commentary Friday that fixed income traders and investors should understand that "Frank has no intention of disturbing the existing arrangement that supports the securities of Fannie Mae and Freddie Mac." "The odds of an actual policy shift to hurt both long-term debt holders and MBS -- they are covered by the same document, after all -- are extraordinarily low," he said. "Investors may choose to sell out of a sense of discomfort, but they should not consider their principal at risk based on what we know today." Write to Diana Golobay. Disclosure: The author holds no relevant investment positions.