Will a 7% Mortgage Threat Doom Fannie and Freddie?

by: Michael Steinberg August 20, 2008 | about stocks: FNM / FRE    

Michael Steinberg

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The Wall Street Journal ( “Rising Cost of Debt Stokes Fears On Freddie's Prospects”) continues its Barron’s-coordinated death march for Fannie Mae (FNM) and Freddie Mac (FRE). The cries of foreclosures, mark to market losses, technical insolvency, and bad gambles on Alt-A and subprime have not been effective enough. The GSE stock prices have been driven down, but the Treasury is not acting fast enough to satisfy the Journal’s constituency. Treasury wants Fannie and Freddie to survive, but is planning for the worst. That’s not good enough for the shorts and the GSE bond speculators!

Now for plan B: Rally the public to be worried about “high” mortgage interest rates. The kill Fannie/Freddie crowd has two arguments. The first is that housing prices cannot stabilize with 6.5% to 7% mortgage interest rates. Second, Freddie was forced to pay the highest spread to treasuries ever on 5 year notes.

In the words of a politician that caused grief for presidential candidate John McCain, there’s too much crying out there. A 7% mortgage rate is not out of sync with history. And if such a rate does not stabilize housing prices, then house prices are in fact too high. Don’t forget the retail mortgage interest rate includes insurance fees from the FHA and the GSEs which can be as high as 1.5% annually on the unpaid principal. That gives a net interest charge of 5.5%, allowing a reasonable spread over 10 year treasuries. The press tries to compare mortgage rates with the Fed funds rate – ridiculous!

The complaint about Freddie’s spread on treasuries is even more ridiculous. A 113 BP spread is not the issue. Any company that can borrow 5 years for 4.172% is doing quite well. Treasury interest rates are severely under both inflation and inflation expectations. It is the cost of insuring mortgages that is driving up mortgage interest rates, not the GSE’s cost of funds.

The profitability gained through charging high fees is precisely what Fannie and Freddie need for recovery. I would like the press to focus more on the GSE’s projected cash flow and less on their balance sheets. It is unfair to doom Fannie and Freddie for shrinking their balance sheets to survive. In essence the Journal is asking that one group of private enterprises (the GSEs) be slaughtered to save another group of private enterprises (the housing industry and banks).

Finally, let’s hear Bill Miller’s reasons for being optimistic in the press.

Disclosures: Author is long FNM and FRE.

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This article has 9 comments:

  •  
    Aug 20 10:00 AM
    Well it seems that Alan Greenspan and his masters will get what they want, the downfall of the GSEs. Congrats Alan way to spearhead the tripling of the national debt.
    Reply | Link to Comment
  •  
    Aug 20 11:38 AM
    " I would like the press to focus more on the GSE’s projected cash flow and less on their balance sheets."

    thanks for explaining that the press is the problem. if you don't understand the importace of a financial firm's balance sheet you're in the wrong business.

    as for bill miller, his views aren't particularly relevant given the fact that he's behaved like an amatuer in riding these stocks all the way down.

    prayer is not an investment strategy.
    Reply | Link to Comment
  •  
    Aug 20 12:29 PM
    What exactly is so wrong with getting rid of the GSEs? I find the Journal's coverage compelling. Housing is already one of the most subsidized commodities in this country, is it a wonder why housing gets overbuilt? Why do the GSEs need to exist at all? If we need to rescue them because they are to big to fail, then maybe the real solution is for them not to be so big, or better yet, not to exist at all.

    I have yet to read a cogent, logical argument as to why we need the GSEs.

    As for Bill Miller, I agree with the last comment. What a joker, even if your post made any sense, you lost all credibility with that last sentence. If this bear market has taught us anything it's that most "successful" fund managers or gurus are not as smart or savvy as the media wants us to think. They simply employed a strategy that worked until it stopped working. Don't be fooled by randomness.
    Reply | Link to Comment
  •  
    Aug 20 12:42 PM
    Monday, July 14, 2008 - Freddie and Fannie: What should be done now

    Our recommendations for dealing with the housing GSEs are as follows:

    1. Freddie Mac should be closed. Having a second housing GSE was supposed to provide competition and serve as a check on the first housing GSE, Fannie Mae. Clearly, this did not work. No need to continue, so:

    2. Merge Freddie and Fannie. Instead of two failing agencies, we now have one. Allows for a concentration of focus, effort. Stabilize the resulting institution.

    3. After one year, move Fannie back into HUD. Fannie Mae was separated from HUD in 1968. Time to reverse this. Moving Fannie into HUD extends the full faith and credit guarantee umbrella.
    Reply | Link to Comment
  •  
    Aug 20 03:16 PM
    "Disclosures: Author is long FNM and FRE."

    Well I guess somebody has to be long these companies.

    The GSEs are dead men walking for reasons mostly of their own making. The GSE shareholders and management have had how many years wetting their beaks whilst enjoying their "implicit guarantee"? Well, I guess they should have been smart enough to realize that if they ever needed to call in that market management and equity were going to be taking a beating.

    I agree with the previous poster. The only sane course now is to make the de facto nationalization official. In which case there is no reason to have two entities. Freddie was created in the first place to provide some semblance of competition for Fannie.

    Economists have shown that much of the subsidy that the GSEs were supposed to be providing to the mortgage market accrued to management and shareholders. The end of the GSEs would not mean the end of mortgage securitization.
    Reply | Link to Comment
  •  
    Aug 20 05:17 PM
    I don't understand what the big fuss is. The GSEs are government supported entities. A lot of the carnage that has happened has been caused by the government. They just mandated that mortgages be insured up to $417,000 by FNM and FRE. They have to take responsibilty for their actions. IF we can spend over $500 billion on a useless war why can't the government support its commitment in its own soil. People have invested in these two entities because of the inherent support, the given word by the U.S. government. Now they want to support the banks, the brokerages, the investment banks like Bear & Stearns who were not made any promises to? Congress just set up $300 billion for the homeowner bailout - why? No promises were ever made to them! What will happen for the FNM-FRE bond holders in all the fixed income securities tied to IRAs and 401Ks? Paulson, Bernanki and this entire administration need to be fired! What a buch of crooks - this all a setup to shift all the wealth to the rich.
    Reply | Link to Comment
  •  
    Aug 21 12:12 PM
    You wrote:
    In essence the Journal is asking that one group of private enterprises (the GSEs) be slaughtered to save another group of private enterprises (the housing industry and banks).
    You miss the point. They are hybrids, not private companies. The deal they made was that when times got tough they would act in the best interests of the country not their shareholders. In exchange they received an implicit government guarantee of their debt that let them rake in excess profits in the good times.
    Sorry, you can't have it both ways.
    Reply | Link to Comment
  •  
    Aug 21 01:28 PM
    I sold off positions in Citigroup and Freddie Mac long ago, didn't like what I was seeing. FRE and FNM are not worth buying at present levels. They are hybrids and subject to the whims of government. Recall the investment banks whined mightily about unfair competition when things were good. The basic notion of creation of a secondary market in mortgages is good policy if it frees up lenders to make more realistic loans but that wasn't happening, was it? I have no confidence in the present and past leadership of the Fed or this administration because of the disconnect between any sane fiscal policy and realistic monetary policy. Plenty of blame to spread around, but the bottom line is shareholders in either GSE are not going to see daylight and the public loses.
    Reply | Link to Comment
  •  
    Aug 22 07:27 AM
    These gov supported monopolies should be broken up into many small mortgage companies without any gov backup. They should not be allowed again to grow into huge monopolies which can threaten the nations solvency.

    Remember the worst monopolies are those sponsored by the gov..
    Reply | Link to Comment
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