Policy reversed, Fannie and Freddie will buy junk mortgages

By James Tyson and Jody Shenn
Bloomberg News Service
Wednesday, September 19, 2007

http://quote.bloomberg.com/apps/news?pid=20601087&sid=a7W8FamllDBg

WASHINGTON -- The Bush administration reversed policy, allowing Fannie Mae and Freddie Mac, the two largest sources of money for U.S. home loans, to expand their investments in an effort to make mortgages easier to get.

The Office of Federal Housing Enterprise Oversight will permit Washington-based Fannie Mae and Freddie Mac to boost their loan portfolios by about 2 percent a year beyond a cap of about $1.5 trillion. Just two days ago, Federal Reserve Chairman Ben S. Bernanke in a letter to Rep. Barney Frank said easing restrictions on the companies could prove to be "ill-advised."

The increase is part of a response by President George W. Bush to the deepening U.S. housing slump, where foreclosures are at a record. Bush, after resisting requests to raise the limits, last month said he would allow the Federal Housing Administration to help subprime borrowers who have fallen behind in their mortgages to refinance. The higher limits will help Fannie Mae and Freddie Mac buy loans made to people with poor credit, Ofheo said.

The change is "moderately helpful," Jim Vogel, head of agency debt research at FTN Financial in Memphis, Tennessee, said today in an e-mail.

Fannie Mae would be able to add $12 billion of mortgage assets under the new rules, and McLean, Virginia-based Freddie Mac would be able to buy $22 billion, Credit Suisse Group analysts Moshe Orenbuch and Kerry Hueston in New York, said in a report.

Bush and Ofheo Director James B. Lockhart rejected requests last month from Fannie Mae, Freddie Mac and Democrats to allow the companies to buy more mortgages to fill a gap left by investors who fled the market. Bush and Ofheo cited the companies' failure to get their accounts in order after $11.3 billion in accounting misstatements.

As the housing crisis worsened, defaults on subprime loans rose to 10-year highs and foreclosures in August more than doubled from a year earlier. The Federal Reserve yesterday cut its benchmark rate a half-point to help prevent the real estate market from driving the economy into recession. Fannie Mae and Freddie Mac buy or guarantee about 40 percent of the mortgage market. Increased demand from the companies may encourage lenders to extend more home loans.

Ofheo set a portfolio cap of $735 billion for both companies for the third quarter that will increase 0.5 percent each quarter. The agency will measure portfolio size based on an average of monthly closing values during the three-month period of a quarter rather than the end-of-quarter closing value, Ofheo said.

Freddie Mac already had a 2 percent annual growth cap on its $712.1 billion portfolio. Fannie Mae's portfolio was limited to $727.2 billion. The two companies also can't buy mortgages of more than $417,000 for a single-family home in most states.

Fannie Mae jumped $1.44, or 2.3 percent, to $63.98 in New York Stock Exchange composite trading. The stock is up 7.7 percent this year. Freddie Mac gained $1.64, or 2.7 percent, to $61.16 and is down 9.9 percent this year.

Bernanke, in a Sept. 17 letter to House Financial Services Committee Chairman Frank, echoed the Bush administration view that the creation by Congress of a tougher regulator for Fannie Mae and Freddie Mac should precede any relaxation of the portfolio limits.

"Both the size and composition of the portfolios should be tied to reforms that both reduce the systemic risks posed by the portfolios and also clarify the public purpose," Bernanke said in the letter to Frank, a Democrat from Massachusetts.

Today's increase was criticized as too low by officials at Fannie Mae, Freddie Mac and housing lobbyists, who said it would do little to help revive the $11.5 trillion mortgage market. Senate Banking Committee Chairman Christopher Dodd, Senator Charles Schumer and other Democrats said Ofheo hasn't done enough to reverse the housing slump.

The change "is a drop in the bucket and will have zero impact," said Howard Glaser, a mortgage industry consultant who was chief legal adviser to former Housing and Urban Development Department Secretary Andrew Cuomo. Ofheo's "appearance of an effort is worse than doing nothing at all."

Fannie Mae Chief Executive Officer Daniel Mudd last month asked Ofheo to increase its home-loan portfolio limit by 10 percent, or $72 billion. Schumer of New York this month introduced legislation that would permit the companies to buy $145 billion more in home loans.

"The more effective response, given the extent of the market disruption, would be to raise our portfolio cap by at least 10 percent so that we can more fully address the ongoing turmoil and bring much-needed liquidity to the mortgage market," Fannie Mae spokesman Brian Faith said. Freddie Mac spokesman David Palombi said "more should be done" to help alleviate the credit crunch.

The Ofheo decision "is a baby step," Dodd, of Connecticut, told reporters today, noting he called last month for a 5 percent increase in the portfolio constraints.

Ofheo won't lift the limits until the companies finish an overhaul of accounting and internal controls and restore timely filing of quarterly financial statements, Lockhart said. Also, Congress must pass legislation creating a stronger supervisor for the two government-sponsored enterprises, he said.

"What is really needed is for the two companies to remediate themselves and also for Congress to act on the GSE legislation," Lockhart said in an interview in Washington.

U.S. Treasury Secretary Henry Paulson and other Treasury officials have repeatedly said since last month that Fannie Mae and Freddie Mac have a limited ability to revive mortgage credit because federal law allows them to only purchase home loans valued up to $417,000.

The market for such "conforming loans" is more stable than the market for "jumbo loans" exceeding $417,000 and other areas of mortgage finance, Paulson said.

Senator Richard Shelby of Alabama, the banking committee's senior Republican, backed Ofheo's move, saying it "will enable Fannie and Freddie to grow some in a dire time."

Created by Congress to increase financing for home loans, Fannie Mae and Freddie Mac profit by holding mortgages and mortgage-backed securities as investments and by charging a fee to guarantee and package loans as securities for sale to investors.

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