While investors say they are worried about there possibly being no federal guarantee, any concerns haven’t yet shown up in bond prices. And mortgage rates remain low.
Before the 2008 financial crisis, which prompted the U.S.’s takeover of Fannie and Freddie, investors believed that the government would bail the companies out and backstop their mortgage securities, even though no law or regulation said that was the case. Critics say Fannie and Freddie exploited that “implicit guarantee” by holding too little capital and dangerously ramping up risk, moves that ultimately led to the companies’ needing a rescue.
Treasury Funds
In conservatorship, Fannie and Freddie have been assumed to have the full backing of the U.S. government. That perception is bolstered by the fact that if the companies suffer losses, they can draw on $258 billion from the Treasury.
Those billions of dollars could help mitigate the need for an explicit guarantee of mortgage securities, if the funds remained available to a privatized Fannie and Freddie. Calabria and Mnuchin have also said that they want the companies to raise enough capital to endure a financial meltdown, and such a total could exceed $200 billion.
But some mortgage-finance experts argue that all that money still wouldn’t be adequate to assuage bond investors. Chris Whalen, a former debt rater at Kroll Bond Rating Agency, said regulators might be using the threat of releasing Fannie and Freddie without a guarantee to force Congress to agree to a legislative fix to end the conservatorships, something lawmakers have repeatedly fallen short of since the 2008 crisis.
“Part of me thinks that they’re just bluffing and they want Congress to act,” said Whalen, chairman of Whalen Global Advisors. “When you start messing with the basic infrastructure in the mortgage finance world, you’re looking at some serious risk. When volumes fall in the mortgage industry, the Realtors, home-builders and bankers are going to come to Washington and crucify these lawmakers.”
Realtors Worried
There’s evidence that’s already happening. The National Association of Realtors sent Calabria a June 3 letter saying “a curtailed or eliminated guarantee could raise costs and threaten access to credit.”
Another potential impact of freeing Fannie and Freddie without an explicit guarantee is uncertainty over whether they could maintain their AAA credit ratings -- the highest possible.
“Absent some sovereign support that we could point to, I think we would have to question whether the AAA rating that we have on the enterprises would still hold,” Fitch Ratings’ Chris Wolfe said in an interview.
Scott Simon, the former head of mortgage-backed securities at Pacific Investment Management Co., said many bond investors, including foreign central banks, bought Fannie and Freddie securities because the assets were perceived to be free of credit risk. Releasing the companies without a clear government backstop would test that assumption, as well as much of the infrastructure that underpins the U.S. mortgage market, he said.