Fannie & Freddie – reports of their death are greatly exaggerated…

The news stories are again surfacing about Congress considering a new federal housing agency to replace the  troubled agencies now supporting the functioning of our mortgage market. As you may recall, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) were placed under federal receivership during the 2008 crisis, and they have remained there to this day. 

Fannie & Freddie would be perfectly happy to go about their business of facilitating a functioning residential mortgage market under the protection of its federal receivership (think trustee) were it not for a particularly bothersome fact: they are making money again – and lots of it.  In fact, the two agencies just paid $15 billion back to the US Treasury in just the past 90 days as part of the terms of its 2008 rescue, and this has pushed the US Congress & President Obama to each raise the idea that it is time for Fannie & Freddie to draw to a close.

But, wait, you say: don’t we own a whole mess of  Fannie & Freddie bonds?  If these two agencies go away, what will become of those bonds?  The first answer is easy: yes, we own quite a fair amount of agency debt.  As two of the largest debt issuers in the world, just about any bond portfolio will have exposure to these entities, and NWIC is no different.  The second question is the one with which we are more concerned.

The simple truth is that there are roughly $3 trillion (yes, with a T) in direct obligations that need to find a home, and simply ignoring them is not an option (note, we are not talking about “mortgage bonds” that are backed by residential mortgages – these are indirect obligations of the agencies through their guarantees).  The default by a US government agency on this size obligation would make for a global financial catastrophe that would put 2008 to shame. There really is no choice but to repay these bonds as they come due, so that’s exactly what we expect to see happen.  Unfortunately, the news media and government talking heads gloss over this fact, leaving these details to the imagination.

Fortunately for our clients, these details are not something we like to leave to the imagination, so we have taken the time to see exactly what the latest proposal says about these existing bonds.  Sen. Corker from Tennessee has proposed legislation that you can see here, and it’s not until page 132 that we see any mention of the existing obligations of Fannie & Freddie.  Page 134 finally has the important information we’ve been looking for:

Guaranty

There’s not much to look at, but those are the magic words in the current proposal that should give you comfort.  In fact, we’d argue that the terms of support for Fannie & Freddie bonds are even stronger under this proposal.  Originally, the guaranty of these agencies’ debt was implicit – an assumption on the part of investors that is anything ever happened to the ability of the agencies to pay their obligations that the US Treasury would ride to the rescue.  Indeed, that’s exactly what happened in 2008, but the language above in Senator Corker’s bill would make that guaranty an explicit one and remove any further speculation as to the fate of Fannie & Freddie bonds.

To be sure, there is much work to be done before any new federal mortgage entity is created.  Some suggest that it could easily be another 3-4 years before the sausage making of Congress is compete on this, but in the meanwhile we think Fannie & Freddie bonds will (and will continue to) offer our clients a safe, liquid, and appropriate asset class to use in fixed income portfolio construction.