The cost to fix Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), the government-backed mortgage companies that bought or guaranteed three-quarters of all U.S. home loans last year, could run as high as $1 trillion, according to a report by Bloomberg News released yesterday (Tuesday).
The minimum amount required to keep them afloat will be $160 billion, or $15 billion more than they have already drawn from an unlimited line of government credit granted to keep the home mortgage market functioning. That exceeds the amount already spent on bailouts for American International Group Inc. (NYSE: AIG), General Motors Co. or Citigroup Inc. (NYSE: C).
"It is the mother of all bailouts," Edward Pinto, a former chief credit officer at Fannie Mae, who is now a consultant to the mortgage-finance industry told Bloomberg.
Fannie and Freddie own or guarantee 53% of the nation's $10.7 trillion in residential mortgages, according to a June 10 Federal Reserve report. Their books are loaded with millions of bad loans, and delinquencies are on the rise.
Borrowers were late making payments on $338.4 billion worth of Fannie and Freddie loans at the end of March, up from $206.1 billion a year earlier, according to the companies' first quarter filings at the Securities and Exchange Commission (SEC).
The private mortgage-backed securities market evaporated during the 2008 credit crisis, drying up all the liquidity in mortgage markets. The banks simply refused to take on the risks associated with mortgage loans and stopped lending unless those loans could be sold to Fannie and Freddie. To a large extent that situation still exists today, Federal Reserve Chairman Ben Bernanke said earlier this month.
Any solution to the problem will depend on the strength of the economic recovery, especially in how it affects unemployment and interest rates that will drive any rebound in the housing market.
If housing prices continue to fall, the companies may need more funding.
A 20% loss on the companies' loans and guarantees could cause even more damage, Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania, told Bloomberg.
"One trillion dollars is a reasonable worst-case scenario for the companies," Egan said.
How to stop the bleeding and convert the two mortgage giants to viable businesses is the biggest problem facing Congress as it negotiates a Wall Street overhaul.
For now, the Obama administration is delaying any action to keep losses off the government's books as Democrats ponder their fate in the coming congressional elections.
Allowing the companies to go under and hoping that private financing will fill the void isn't realistic, analysts say. It would require at least two years of rising property values for private companies to return to the mortgage-securitization market, Robert Van Order, Freddie's former chief international economist told Bloomberg.
In order to get private money flowing again, the Mortgage Bankers Association in March proposed that a new breed of mortgage-backed securities be structured with a federally guaranteed wrap that would provide an explicit credit guarantee.
That proposal drew heavy fire for being too favorable to the banks from several quarters, including retired hedge-fund manager Shah Gilani.
"What matters to the bankers is that they don't have to assume any risk on the mortgages they originate as long as the government guarantees them. As long as bankers can generate fees from originating loans...and borrow additional cheap money from the U.S. Federal Reserve," said Gilani, who edits the Capital Wave Forecast advisory service.
Another idea under consideration by the Obama administration involves reconstituting Fannie and Freddie into a "good bank" with performing loans and a "bad bank" to absorb the bad loans. That could cost taxpayers as much as $290 billion, according to a May estimate by Credit Suisse (NYSE ADR: CS) analysts.
Others have come out in favor of simply nationalizing the companies due to the overall importance of the housing market to the U.S. economy.
Residential real estate - the money spent on rent, mortgage payments, construction, remodeling, utilities and brokers' fees - accounted for about 17% of gross domestic product in 2009, according to the National Association of Home Builders.
"We must accept the fact that keeping the mortgage market liquid is so important to our economy that it must be guaranteed by the government," columnist Steven A. Blumenthal wrote yesterday in The Wall Street Journal. "There is no reason why government agencies and their employees cannot administer programs that provide guarantees of payment of principal and interest, and securitization of mortgages."
Whatever the eventual solution, most analysts say the government needs to make sure the companies survive, even if they draw billions of dollars from the Treasury Department for the foreseeable future.
The price tag of supporting Fannie and Freddie "needs to be evaluated against the cost of not having a mortgage market," Phyllis Caldwell, chief of the Treasury's Homeownership Preservation Office told Bloomberg.
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