Toomre Capital Markets LLC

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Fannie Mae, Freddie Mac and Future of Mortgage Finance

Toomre Capital Markets LLC ("TCM") has been quite busy during the past few weeks on client work ahead of the summer vacation period. As a result, there has been limited time to update this blog. Today's news of the Treasury Department's defense of the struggling GSE's known as Fannie Mae and Freddie Mac though deserves some comment.

That both of these GSE's need to be supported in at least an oral sense is more than a ripple in the Capital Markets pond. It is much more like a major wave. Just what the final cost to tax payers will be remains to be seen. TCM suspects that the final bill will not be known until well after residential home prices stabilize and even begin to appreciate again. No doubt, though, the costs will be significant.

Lost in all of the GSE consternation is the lack of discussion about the critical policy decision on the future of mortgage finance in the United States. TCM has highlighted this critical issue before. Until the late 1980s, the S&L's were the primary holders of mortgage debt. Commercial banks also have owned some mortgage debt (with significant capital haircuts). The relatively lower capital requirements and the ability to "turn" the mortgage origination portfolios led to the rapid growth in securitization and the funding of mortgage debt through investors in the capital markets.

As the credit crunch has evolved over the past eighteen months, many of the large institutional investors limited or even decreased their exposure to various mortgage debt instruments. Hence, to at least some extent, most mortgage originators have had to become portfolio lenders. Many of those originators are now reaching their portfolio holding limits and are ceasing to originate new mortgage loans unless there is near certainty that those loans can be sold in the secondary market(s). At present, this means selling the loans into either a FHA, FNMA or FHLMC pooled security.

Policy makers at present seem to be counting on the continued acceptance of these mortgage-backed securities with institutional investors. Have they considered what might happen if such investors "go on strike", especially if there is collective concern by debt investors about FHA, FNMA and FHLMC and their ability to make good on their contractual and implied obligations? Just where is mortgage debt going to be held and at what cost (especially regarding capital adequacy charges)?

Projecting out into the future a bit, does not this concern about the future of mortgage finance translate into higher mortgage costs? And those higher mortgage costs into less demand for residential housing which in turn also suggests a likelihood of further downward pressure on housing prices from reduced demand? Sadly, this probability makes TCM think that the credit crunch will be with the credit markets for at least another six quarters.

Reader thoughts and comments are welcome.