The US recovery that has sufficiently emboldened the Federal Reserve to signal an eventual end to quantitative easing is built on the improvement in the housing market. In many areas house prices are at their highest levels since 2006, which is fuelling a sense of consumer optimism (as long as you turn a blind eye to the fact that it is often large-scale institutional buying that is behind the numbers). Another thing that the markets have long turned a blind eye to is the fact that through its conservatorship of Fannie Mae and Freddie Mac the US government controls 90% of the US mortgage market. At some point the re-privatization of this market is going to have to be addressed. A bipartisan group of senators led by Bob Corker and Mark Warner certainly think so, and recently proposed the establishment of a backstop insurer of RMBS called the Federal Mortgage Insurance Corp to replace the incumbent GSEs. This entity would insure the loans only after a 10% first-loss capital cushion provided by the private sector had been used up. The FMIC concept is modelled on the Federal Deposit Insurance Corp and is funded in the same manner via industry fees. The desire to see Freddie and Fannie wound up is not, however, universal. The US Treasury holds $188 billion in Fannie Mae and Freddie Mac senior preferred stock and almost 80% of outstanding common stock. By May this year there were $6.7 trillion of mortgages on its books, which accounted for nearly half of the $16 trillion US national debt. However, in 2012 the Fed made $77 billion net income on these mortgages and has made $250 billion net income on mortgages in the past three years. And it has done this by doing exactly the type of maturity transformation that the banks have been so criticized for: funding 30-year mortgages with short-term money. It has been a very nice investment for the US government indeed a recent editorial in Barrons suggested that the US Treasury has so far received dividends of $65 billion from the two GSEs and if they remain in conservatorship for another 10 years (and the housing market recovery is sustained) it will get its money back plus $50 billion. It is perhaps no surprise, therefore, to see the GSEs working on first-loss products of their own in order to try to deflect attention from the quantity of risk they hold. Last month, news emerged of new Freddie Mac Structured Agency Credit Risk Securities (SACRs). These will be unrated securities backed by first-loss risk in certain government-guaranteed MBS and might soon be issued via a deal that Credit Suisse is understood to have been working on for 18 months. Details are sketchy, but any trade could be two senior/subordinated sequential pay floating-rate tranches that would be targeted at traditional mortgage credit buyers, and high-yield and crossover buyers. A number of hedge funds, including Paulson & Co, Perry Capital and Carlyle-owned Claren Road Asset Management, have recently been building positions in GSE preferred shares. Fannie and Freddie had combined pre-tax profits of $28 billion for 2012 and could easily raise $182 billion via an IPO. Despite years of political wrangling, the battle over their future has only just begun.