The future of US mortgage agencies Fannie Mae and Freddie Mac is in the hands of politicians. Hours after the $200 billion bailout was announced in early September, Senate Democrats were calling for hearings to analyse the causes of the government-sponsored entities’ (GSE) demise. How the agencies look after the credit crunch abates – if they survive at all – will largely depend on whether the Republicans or Democrats are in charge after the November election.
The Bush administration has always been clear when it comes to the GSEs they offer too much potential for systemic risk. This view has been at least partly borne out over the past months. Under a McCain administration, whats left of the GSEs would likely be privatized or phased out completely. Initial ideas from Democrats such as senator Barry Frank of Massachusetts indicate a preference for a hybrid structure. That means the GSEs would be privatized. However, an entity, potentially with a state interest, would be established to help low-income families access mortgage finance.
So far, the bail-out has been very much to the benefit of the GSEs bondholders. In the aftermath, spreads on the senior debt of both GSEs tightened by 25 to 30bp depending on maturity. The tightening trend is expected to continue. While asset manager Pimco is said to have totted up $1.7 billion in gains on its GSE bets, shareholders in Fannie and Freddie are left with pennies.
"The bailout has bought the two entities 15 to 18 months while the government takes them over," says Ajay Rajadhyaksha, head of US fixed-income strategy at Barclays Capital in New York. "The existing shareholders have been hurt. Both stocks are trading at below a dollar now. Regardless of whether they come back, its unlikely they come back to the benefit of the existing shareholders."
The bail-outs impact was felt perhaps most profoundly on the macroeconomic level. Now that at least one question mark hanging over the US economy has been eliminated, it remains to be seen whether the GSE rescue reinvigorates the moribund mortgage market and encourages lending.
The difficult work reforming the US mortgage markets is still very much in its early stages. Treasury secretary Hank Paulson has already brought in best practice for covered bonds to give lenders another funding option but as the economy weakens, increasing foreclosures, the housing market will remain under pressure.
One early lesson has been learnt. Paulson has pointed out that there tends to be a conflict of interest between an entity that exists to benefit the housing market while at the same time benefiting private shareholders. Perhaps this observation is an indication of things to come.