Agency lenders could shed toxic mortgages
August 6, 2009 by admin
The nation’s largest agency lenders, Fannie Mae and Freddie Mac, are again back in the news as the government is looking for a solution to improve the financial viability of both firms. Fannie Mae and Freddie Mac are the two largest mortgage agency lenders in the U.S. and they play a critical role in the mortgage industry. The companies are the two largest investors in securitizing mortgage backed loan securities. Mortgage lenders, who offer conventional loans, are likely to be underwriting these mortgages to guidelines set by Fannie Mae or Freddie Mac.
The severe downturn with the U.S. housing market over the last three years has forced the companies to accept billions of dollars of capital from the government. The companies, similar to how a bank lends money, utilized a leverage based model. The leverage based model allowed the companies to lend out money at ratios of 10 to 1 (ten billion in loans/to one billion in assets). These leverage ratios were expanded in the late 90’s to allow the companies to have more flexibility to increase their asset base. The company’s capital ratios became a large concern as the value of homes began to decline and home foreclosures began to rapidly increase. This rapid deterioration within their portfolios quickly left the companies short of their required capital ratios and threatened to collapse the U.S. mortgage industry. The government stepped in and provided both companies will billions of dollars in capital to help them remain solvent.
This week, the government began to float out new ideas on how to reshape the companies. Both Fannie Mae and Freddie Mac are publicly traded companies, which have seen their share prices lose significant value and now trade well under $1 per share. The government has allowed the companies to remain publicly traded despite there flirtations with going out of business. There is new speculation that the government could try to merge the companies together or potentially remove the bad asset loans from the company’s balance sheets.
The idea of removing toxic assets from the Fannie Mae and Freddie Mac’s balance sheet would be done through the creation of a bad bank. The term “bad bank†has been floated around in multiple scenarios as the government has looked for ways to best use money from the TARP program. Creating a bad bank, essentially allows the government to remove the assets from the companies balance sheets, immediately improving Fannie Mae and Freddie Mac’s capital ratios. The creation of a bad bank is a strong indication that challenges remain in the secondary lending marketplace. In years past, the secondary market was an active area for the securitization and sale of mortgage backed loans that were viewed as non conforming (sub prime, jumbo loans, second liens). This marketplace seized up during the credit collapse and has yet to return. Ensuring that Fannie Mae and Freddie Mac remain solvent and active in there current roles in the housing market is critical to the administrations plans on helping the housing markets. Historically low mortgage rates and tax rebates from the government are finally helping to bring buyers into the marketplace.