Plans to Relax Capital Constraints at Fannie, Freddie Nearing Completion

Can Fannie Mae and Freddie Mac ride to the rescue of the mortgage market? Policymakers are clearly hoping so, with the Wall Street Journal reporting Tuesday that plans to reduce capital constraints at the government-sponsored enterprises are in the “final stages.” Office of Federal Housing Enterprise Oversight director James Lockhart first suggested the plan in late February. Part of the plan, however, would involve both GSEs raising additional capital — something that both have said in recent weeks they don’t feel they need to do. From the WSJ:

Fannie Mae and Freddie Mac would both be expected to raise more capital, providing more of a shock absorber against potential losses. “I’m anticipating a conversation we’ll be having with Fannie and Freddie about acquiring more capital here,” Senate Banking Committee Chairman Christopher Dodd told reporters yesterday. The Connecticut Democrat said the companies would have to find a way to “walk the line between protecting shareholder interest” and meeting their mission to promote affordable housing.

Investors have speculated recently that each GSE may need as much as $10 billion in additional funds to cushion against the additional risk tied to a bevy of bad mortgages now tearing up much of the secondary market. The Financial Times’ John Dizard weighed in on the plan Tuesday as well, saying that “we are now about to get into the same mess we only crawled out of about three years ago.” Dizard suggests it is only a matter of time before the GSEs are nationalized, given the risks they’re now being forced to take on:

If this balance sheet growth does happen, the GSEs will be back to assuming the same rate risks that were so alarming four or five years ago, only bigger. And they will be attempting to hedge their rate risks using counterparties that are far more capital constrained than before. I believe it more likely that before we get to that point again, the GSEs will be formally nationalised. The Bush administration is just kicking the can a little further down the road. These “public-private” mutants will simply become public agencies. There is no way to raise the equity capital for them to remain halfway in the private sector. In any event, the foreign central banks and related institutions have made clear to the US government that it will be held responsible for the GSEs’ debt.

Looking ahead, should nationalization be the end game here, we’ll likely be facing a pretty acrimonious national debate over conforming limits — realtors and other consumer advocates will clamor for the loan limit to be raised to $625,000 across the board, as they already are, but on the newly-minted grounds of “ensuring equal and fair access to government funds.” Investor expecations of fresh capital at the GSEs set shares in Fannie Mae and Freddie Mac soaring Tuesday morning. Fannie Mae shares were up more than 18 percent to $26.21, while Freddie’s shares were up nearly 16 percent to $23.83 as of when this story was published. Disclosure: The author owned no positions in any publicly-traded firms mentioned in this story when it was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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