Fannie, Freddie to Buy More Bad Loans

Via the IHT (Paulson saying he would consider allowing Fannie Mae, Freddie Mac to buy larger mortgages) and Bloomberg (Fannie Mae, Freddie Mac Regulator Eases Asset Limits), regulatory limits on the two GSEs will be relaxed, in order to allow them to buy, in aggregate, $36 billion of mortgage-backed securities containing "jumbo" loans --- those over the "confirming" limit of $417,000. The changes will not go into effect until companies have cleaned up their ongoing accounting messes and are able to file quarterly financial statements. The increase represents a 2% growth in the two entities' loan portfolios. Fannie had requested a 10% increase, while some members of congress proposed a 5%.

The GSEs are financial institutions who purchase mortgage-backed securities and then either issue offsetting bonds with a form of credit insurance attached, or hold the securities in their own portfolio. They are quasi-governmental, quasi-private entities. They are subject to more lenient capital requirements, their securities receive special treatment in certain bank capital regulations, and their debt is possibly underwritten by the US government, though this is not entirely clear. These lowered their cost of funding compared to other private sector financial institutions and have enabled them to take on more leverage.

Doug Noland, who has been reporting on the GSEs for several years in his weekly Credit Bubble Bulletin believes that the GSEs were instrumental in getting the mortgage finance bubble off the ground. But as they have both run into accounting scandals in recent years (http://en.wikipedia.org/wiki/Fannie_mae#Accounting_scandal, Freddie), their ability to accumulate more portfolio assets has been limited.

In sum, the recent changes don't appear to have much impact due to their small size of these entities. The story is worth watching, though, since the GSEs are a likely focus of any larger bailout plans that may be in the works to rescue the holders of defaulted or impaired mortgage-backed securities.

Robert Blumen

Robert Blumen is an independent software developer based in San Francisco, California