Bank Stocks Fall Again

The Washington Post

 

Bank stocks got hammered for a second straight day Friday amid concern that mortgage issuers could face a new wave of red ink related to shoddy lending and foreclosure practices.

The share price of Bank of America, the nation's largest bank, fell 9.1 percent over the past week to close at a low for the year, as analysts said it might have set aside too little money to meet coming costs.

Companies that issued and service mortgages face a triple threat.

First, their efforts to seize and liquidate real estate held by delinquent borrowers may be delayed as they review reports of forged signatures, missing paperwork and other problems plaguing the foreclosures they have initiated.

Second, they could get drawn into a costly legal morass over allegations that they did not properly transfer loan documents when they pooled mortgages into securities that were sold to investors around the world.

Third, they could be forced to buy back billions of dollars of improperly issued loans that were sold to investors, such as the government-backed Fannie Mae and Freddie Mac.

The third issue is far from new, but it became cause for more concern this week as recent disclosures about sloppy or fraudulent documentation in the foreclosure process prompted investors to reassess the potential stakes.

The loan-servicing companies also face a Monday deadline from Freddie Mac to report any problems in their foreclosure practices.

On Friday, Standard & Poor's Equity Research downgraded Bank of America stock from "strong buy" to "hold." The ratings firm said it had "a lower level of confidence" that the bank "has adequately prepared for, and reserved for, future mortgage repurchase demands . . . and for the potential administrative and legal costs of the foreclosure crisis."

In an interview, Standard & Poor's analyst Erik Oja said that the crisis "threatens to morph into something perhaps uncontrolled . . . something very difficult to quantify."

Bank of America is seen as especially vulnerable because it took over Countrywide, one of the firms most heavily criticized for its lending practices during the housing bubble. Bank of America's shares fell 4.9 percent Friday.

As of mid-year, the bank faced unresolved claims that it repurchase $11.1 billion of problem loans, according to its last quarterly report. The bank had put $3.9 billion in reserve to cover such costs.

Bank of America is scheduled to release its next quarterly report Tuesday. A bank spokesman declined to go beyond past disclosures.

Other major banks felt the sting of the foreclosure crisis Friday. Wells Fargo's stock fell 4.6 percent, JPMorgan Chase's fell 4.1 percent, and Citigroup's fell 2.7 percent. By contrast, the Standard & Poor's 500 index, a broad measure of the stock market, rose slightly.

The sharp price movements are partly a reflection of confusion and uncertainty about the scope of the problems and how they will play out. Against that backdrop, a bearish report written in August by a hedge fund called Branch Hill Capital gained widespread attention this week, contributing to the sell-off.

The Branch Hill report said Bank of America could face losses of $74 billion on loan repurchases. The hedge fund disclosed that it was betting that the bank's stock or bonds would decline, and by influencing investors' outlook the report might have helped that bet pay off.

In a rebuttal this week, Oppenheimer & Co. analyst Chris Kotowski said the report was "demonstrably exaggerated and sensational." Oppenheimer disclosed that it, too, might have a conflict because it does business with companies it analyzes.

Fannie and Freddie are threatening to penalize banks if they do not rapidly fix their foreclosure processes.

Delays in foreclosures could cause a profound cash-flow problem for Fannie and Freddie, said Karen Shaw Petrou of Federal Financial Analytics in a report.

The companies have told banks that they will have to pay for any costs the mortgage giants incur as a result of foreclosure delays and are trying to force the banks to buy back billions of dollars of mortgage investments. Goldman Sachs analysts said Friday that these expenses could total $44 billion for the banking industry.

Fannie and Freddie maintain that they were sold the disputed mortgages on deceptive grounds - and that the banks that sold them the loans should be held responsible for the resulting losses. But the industry has resisted efforts by Fannie and Freddie to obtain documents that would show whether the investments were aboveboard.

The Federal Housing Finance Agency, which oversees Fannie and Freddie, recently subpoenaed 64 firms for loan applications, property appraisals and other documents that would show whether Fannie and Freddie or the banks ought to be liable for losses on the mortgage securities.

Pimco’s Gross Urges ‘Full Nationalization’ of Housing Finance

Bloomberg / Business Week

 

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said the U.S. should consider “full nationalization” of the mortgage- finance system as the Obama administration plots the revival of a market that was at the center of the 2008 credit crisis.

“To suggest that there’s a large place for private financing in the future of housing finance is unrealistic,” Gross said today at a U.S. Treasury Department conference in Washington. “Government is part of our future. We need a government balance sheet. To suggest that the private market come back in is simply impractical. It won’t work.”

Treasury Secretary Timothy F. Geithner and Housing and Urban Development Secretary Shaun Donovan gathered housing- industry stakeholders to seek advice as the administration prepares a housing-finance overhaul to be delivered in January. The position taken by Gross, whose firm is among the biggest holders of U.S.-backed mortgage debt, is at odds with industry and government officials who have urged a smaller federal role.

Geithner said the government must reduce its role in housing markets and ensure Fannie Mae and Freddie Mac, the mortgage-finance companies operating under U.S. conservatorship, won’t require future bailouts.

“We will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support,” Geithner said today at the conference.

There’s “no clear consensus” on how to design a new system, he said.

Financial Regulation

“The government’s footprint in the housing market needs to be smaller than it is today,” Donovan said at the conference, adding that Fannie Mae, Freddie Mac and the Federal Housing Administration guarantee more than 90 percent of all mortgage loans. “We need to work to foster a strong but healthy market for private capital to harness the vitality, innovation and creativity in our system in a responsible way.”

Fannie Mae, based in Washington, and Freddie Mac of McLean, Virginia, have been sustained by almost $150 in Treasury aid since September 2008 when they were seized by the government amid soaring losses on mortgage investments. The U.S. has promised unlimited support for the two companies.

‘Smaller’ Role

“We need to begin the process of weaning the markets away from government programs and make room for the private sector to get back into the business of providing mortgages,” Geithner said. “We need to continue working to keep overall mortgage rates reasonably priced.”

The Treasury chief also said that plans to reduce the portfolios of Fannie Mae and Freddie Mac should proceed “in a careful way.” The government wouldn’t back away from the companies’ current obligations, Geithner said.

“We need to make it absolutely clear that we will make sure the GSEs have the resources to meet their financial commitments,” he said.

An explicit government guarantee against catastrophic losses could help attract private capital to the housing-finance system, said Mike Heid, co-president of Wells Fargo Home Mortgage.

The major policy challenge will be “how to marry this government guarantee with the maximum use of private capital in a way that minimizes the risk to the taxpayer, encourages competition, and ensures no one institution is too big to fail,” Heid said.

Geithner said the administration “will not support” a system that relies on taxpayer funds to backstop the gains of private shareholders.

“Fixing this system is one of the most consequential and complicated economic policy problems we face as a country,” he said. “This is a test for Washington. The stakes are high. The housing industry supports millions of jobs. For many Americans, their home is their largest financial asset.”

U.S. home ownership rate fell to 66.9 percent in the second quarter, the lowest level since 1999 and down from a peak of 69.2 percent in 2004, according to Commerce Department figures.

Strategic Default Penalties Threaten Struggling Homeowners

Minnesota Independent

 

Last week, Fannie Mae, the government-sponsored enterprise that buys up mortgage contracts from loan originators to keep the housing market liquid, announced new penalties for homeowners who strategically default.

“Defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure,” the company announced, adding that the policy goes into effect this Thursday, July 1. “Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.”

The new provisions mean that if you strategically default, you likely cannot get a conforming mortgage for seven years. And if you strategically default in some areas, Fannie Mae will come after you in court.

But the Fannie Mae rule — one of several new provisions aimed at penalizing strategic defaulters — raises the possibility that the government and loan servicers might imminently begin targeting an economically vulnerable population, one characterized by housing insecurity and joblessness. It brings up the immediate concern — for both defaulting homeowners and the agencies trying to keep them paying — of how to distinguish “strategic” defaulters from those defaulting because they have no choice. And the data shows that those considering default are by most metrics in financial straits, whether solvent or not.

Consider, for instance, the situation of Charlene Mueller-Holden of Newark, Del. Mueller-Holden is a wife and the mother of two young boys, ages three and six. She lost her $60,000-a-year job as an instructional designer in January 2008. Two and a half years later she has not found a job, despite persistent searching.

“My family is slowly starting to lose the things that everyone takes for granted — a roof over our head and food on the table,” she says. “I was living the American dream. I did everything that everyone tells you to do. I had a great 401k, life insurance and five months’ [worth of] bills sitting in the bank in case of an emergency,” she notes.

The family lives in a modest three-bedroom. After Mueller-Holden exhausted her $1,200-a-month unemployment benefits and the family traded in for a cheaper car, exhausted its savings and tapped its retirement accounts, it has still had trouble keeping up on the mortgage. Her husband brings home around $1,800 a month — the family’s only source of income now. The $1,046.73 monthly mortgage payment started eating up 60 percent of the family’s income. Given food, gas and utilities — plus the cost of keeping the kids clothed and unexpected car repairs — the Mueller-Holdens became hard-up. They refinanced their mortgage under the Home Affordable Modification Plan, seeking to bring the payment down to a sustainable level. Their new payment? $1008.77 — 56 percent of their monthly income. And the balance on the mortgage increased.

“This year my husband’s overtime has been cut out and his hourly salary has been cut and now we are just grateful he has a job,” Mueller-Holden says. “We are beyond struggling. Each month I have to go through our bills to see which one might be able to wait, because we have to buy bread and peanut butter so the kids have something to eat. No more vegetables, no more fresh fruit. No new or used clothes for them this year.”

According to Mueller-Holden, it is not a question of whether the family will default on the mortgage if she does not find work, and fast. It is a question of when and how. The family’s credit score is already seriously tarnished. “I used to have an 820,” Mueller-Holden, says, referring to her FICO score. Imminent default and the six- or twelve-month period before actual foreclosure would provide some relief. No other federal program or bank refinancing initiative will. Indeed, the government itself is on the verge of penalizing strategic defaulters. The FHA Reform Act passed by the House but not yet taken up by the Senate excludes strategic defaulters from receiving Federal Housing Administration-backed loans — a provision included with bipartisan backing, including from most Republicans and Rep. Barney Frank (D-Mass.), the head of the House Financial Services Committee.

The question confronting Mueller-Holdens and the millions of other homeowners facing default is this: How will Fannie Mae and other entities going after defaulters decide what “strategic” default really is? Will they qualify? Will the government or their bank come after them, even when they are on the verge of poverty?

Certainly, over the course of the recession, strategic default has emerged as a phenomenon, with a few particularly famous cases of families pulling the plug on the mortgage and heading to Disney World. The most cited study of strategic default, from credit firm Experian and consulting firm Oliver Wyman, found that as many as 588,000 families strategically defaulted nationwide in 2008 — mostly prime and subprime borrowers in the “sand states” worst hit by declines in home values. Experian and Oliver Wyman deemed people defaulters strategic if they went from having “perfect payment histories” to stopping paying the mortgage entirely, intentionally and suddenly. (All in all, more than three million homeowners received foreclosure filings from banks that year, and banks repossessed 850,000 houses.) But a more recent study by the Federal Reserve showed that four in five strategic defaulters walked away only when deeply underwater, and generally after an “income shock,” such as job loss.

Fannie Mae did not respond to repeated requests for clarification about how hard-up homeowners will need to be before they can default without the new penalties. Thus far, none of the housing experts reached by TWI knew the definition either. The FHA Reform Act that might institute federal penalties for some defaulters instructs the Department of Housing and Urban Development to figure it out. But Mike Konczal of the Roosevelt Institute points to the strictures used by one subprime lender in the 1990s: post-mortgage income of less than $400 a month per family member.

By that standard, Fannie Mae would let homeowners like the Mueller-Holdens off of the hook. They live on just $790 a month after taxes and mortgage payments, but before utilities and all other expenses. (Additionally, they attempted to ameliorate their situation through a HAMP refinancing that ultimately proved useless, as Fannie requests hard-hit borrowers do.) But they exemplify the 5.5 million Americans currently in the foreclosure pipeline. A majority have suffered an “income shock,” like job loss. For many, their mortgage is eating up more than half of their post-tax income.

And now, they have Fannie to worry about.

Congressman Says Freddie and Fannie Should be Eliminated

The Wall Street Journal

A top House Democrat on Friday said his committee was preparing to recommend "abolishing" mortgage-finance giants Fannie Mae and Freddie Mac and rebuilding the U.S. housing-finance system from scratch.

"The remedy here is...as I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance," said Rep. Barney Frank (D., Mass.), the chairman of the House Financial Services Committee.

His comments initially rippled through bond markets on concerns that the government might pull away from the mortgage market. Many believe that's unlikely and that any revamp would include continued government involvement. The government took over the companies in September 2008 as loan losses mounted.

Some Republicans have argued that the companies should ultimately be reduced in size and privatized, while at other end of the spectrum, some analysts have recommended turning the companies into government agencies. But several industry groups and academics have suggested that the government is likely to continue playing at least some role in the future of the companies.

One such report came from analysts at Standard & Poor's this past week. "It's hard for us to imagine" how enough capital could be attracted to replace Fannie and Freddie with stand-alone private companies that would be able to offer low-cost funding for 30-year fixed-rate mortgages, the analysts wrote.

Some analysts have argued that starting from scratch could create more problems than they would solve, in part because Fannie and Freddie own or guarantee around half of the nation's $11 trillion in home mortgages. "Blue sky ideas are great, but they take a long time to happen," said Mahesh Swaminathan, senior mortgage strategist at Credit Suisse, at a conference last month. "When you have $5 trillion of agency mortgages, you can't really orphan them."

Mr. Frank, who didn't elaborate on forthcoming recommendations, said last month that one possible revamp could merge some functions of Fannie and Freddie that overlap with the Federal Housing Administration into the government mortgage-insurance agency.

The Obama administration said it will weigh in on how to revamp the companies—and the entire housing-finance system—when it releases its budget next month. Republicans have increasingly criticized the administration for moving to overhaul the financial sector without spelling out plans for Fannie and Freddie.

In a PBS interview on Thursday, Treasury Secretary Timothy Geithner said the legislative process to overhaul Fannie, Freddie and the housing-finance system was unlikely to begin this year. "It's just a complicated thing to get right," he said. "But we are completely supportive and agree completely with the need to make sure that we take a cold, hard look at what the future of those institutions should be in our country."

Freddie Mac To Enter The Bond Market
Reuters Story as posted at the Business Times

NEW YORK - Freddie Mac, one of the largest providers of funding for US housing, is set to break ground in bond markets next week with a new type of commercial mortgage security, a source familiar with the offering said on Friday.

The sale from the government-controlled company could signal some life in the market for mortgage securities that has been the scourge of global financial institutions for weak underwritings and falling asset values.

Freddie Mac is expected to back the bonds with its guarantee, making the securities safer than traditional commercial mortgage-backed securities that provide protection through a system of tiered risks and bond ratings. At about US$1 billion, it would exceed any multifamily bond packaged by Ginnie Mae, the government-owned issuer.

'The offering is likely to be well-received if it is indeed largely, or entirely, supported by Freddie Mac, especially as investors have mostly shunned the traditional CMBS structure,' said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.

The McLean, Virginia-based company already issues and guarantees billions of dollars in residential mortgage-backed securities each month.

Taking assets from Freddie Mac's US$867 billion portfolio may be a sign the company is preparing to wind down its investments in 2010, as mandated by the government in an agreement reached in September, analysts said. Securitised assets also require less capital of Freddie Mac, a key point for a company that has repeatedly needed to tap the US Treasury for survival.

Its sibling rival Fannie Mae recently securitised US$47 billion of its residential loans, which makes the debt easier to sell if needed and is consistent with the federal mandate to wind down its investments, JPMorgan Chase & Co analysts said this week.

The US$700 billion CMBS market has been hammered by signs that credit of US office, retail and apartment buildings is quickly deteriorating and will cause losses to all but the most senior bond investors. Underwritings by investors and banks has been nil since mid-2008, leaving Freddie Mac and Fannie Mae as the few major sources of funding.

Delinquencies in Freddie Mac's US$76 billion multifamily loan investments have tripled this year to 0.9 per cent, but pale next to the 2.29 per cent of the residential mortgages that have led the company to seven straight quarterly losses.

Freddie Mac and Fannie Mae are operating under a legal status known as conservatorship, where they were placed by the government in September to ensure that mortgage losses would not cripple their ability to support housing. The Treasury has agreed to inject up to US$400 billion in capital into the companies to ensure they can keep funding houses and apartments.

Gradually winding down the portfolios next year is seen as a way to reduce risks to taxpayers.

Availability of funding for multifamily housing still leaves a hole in commercial real estate, since Freddie Mac and Fannie Mae are not permissioned for non-housing investments. However, inclusion of CMBS in the Federal Reserve's Term Asset-backed securities Loan Facility has lowered yields in the market and raised hopes that it would restart lending.

Freddie Mac's new surety bonds may be sold as early as Tuesday via a trust organised by Deutsche Bank, the source said.

A Freddie Mac spokesman declined to comment on the issue. The New York Post earlier reported the sale, citing sources. -- REUTERS

Fannie Still Getting Spanked
Story from CNN Money


NEW YORK (CNNMoney.com) -- Fannie Mae, the troubled mortgage finance company, reported a first-quarter loss of $23.2 billion on Friday.

The mortgage giant also reported that it submitted a request for $19 billion from the Treasury Department to cover its losses. That followed a request earlier this year for $15.2 billion to cover 2008 losses.

It also said Treasury has doubled its support level to the company to $200 billion, as President Obama had authorized.

In its quarterly release, Fannie Mae said its entire mortgage portfolio was experiencing increases in delinquency and default rates. It blamed the rise in unemployment, falling home prices and the revaluation of homes in the wake of the economic downturn.

The mortgage company's first-quarter net loss was less than its fourth-quarter loss of $25.2 billion, which occurred immediately after the government takeover.

The most recent quarterly loss is more than 10 times the $2.2 billion net loss reported for the first quarter of 2008, before the government takeover.

Fannie Mae said its diluted loss per common share was $4.09.

Going forward, the mortgage giant said that it fully expects to ask for more financial support from the federal government.

"Due to current trends in the housing and financial markets, we expect to have a net worth deficit in future periods, and therefore will be required to obtain additional funding from the Treasury," said the company, in its quarterly report.

Friday morning's stock rally left Fannie Mae behind. Fannie Mae's (FNM, Fortune 500) stock price, currently less than $1 per share, fell about 7% in the first hour of trading.

Government influence: Fannie Mae said it imposed a moratorium on foreclosures for most of the quarter. But that failed to stop foreclosures from increasing, compared to the prior quarter. The company said it acquired 25,374 single-family homes through foreclosure in the first quarter of 2009, compared to 20,998 in the fourth quarter, 2008.

"I think Fannie Mae is largely used as probably the single largest tool of the government right now to try and reverse the losses in the mortgage market," said David Ursani, analyst for Wall Street Strategies. "As a result of that, a lot of those losses are funneling through [Fannie Mae.]"

Ursani said it's difficult to tell when Fannie Mae's situation will improve, given its unusual status as a government-supported entity, and the dismal state of the mortgage market.

"Fannie Mae, right now, is pretty much part of the government," he said. "I can't really see it becoming independent from the government anytime soon."

Fannie Mae recently went through a change at the top, appointing Michael J. Williams as its new chief executive on April 20. Williams had previously served as chief operating officer.

The former chief executive, Herbert M. Allison, Jr., accepted a new job in April to oversee the $700 billion financial rescue fund, known as the Troubled Asset Relief Program (TARP).

Allison had led the mortgage giant since it was seized by the government in September, along with Freddie Mac

Freddie Mac Honors Promised Bonuses
Story from Yahoo! News

NEW YORK (Reuters) – Freddie Mac, the U.S. mortgage finance giant, on Thursday said it paid $1.3 million in retention bonuses to three executives in late 2008 and so far this year, including a full payout of the award promised to its acting chief financial officer before his shocking death, according to a Securities and Exchange Commission filing.

Freddie Mac paid CFO David Kellermann the first $170,000 installment of the $850,000 bonus in 2008, and honored the rest of the agreement following his apparent suicide on April 22, according to a spokeswoman.

Paul George, executive vice president of human resources and corporate services, and Robert Bostrom, executive vice president and general counsel, received the first installments of controversial retention bonuses approved by Freddie Mac's regulator of $260,000 and $180,000, respectively. Their full bonus payouts through 2010 would be $1.3 million and $900,000.

The retention bonuses came amid an exodus of top management at Freddie Mac after the government forced the company into conservatorship, fearing deep losses from the housing crisis would hurt its ability to support the U.S. housing market. The company is the second-largest provider of residential mortgage money to Raleigh realators, and now a top provider of many commercial properties, including Greensboro MLS listings.

Executives that left the firm took home millions of dollars in compensation in 2008.

Former Chief Executive Officer Richard Syron earned $4.1 million in total compensation last year, down from more than $18 million in 2007, according to the filing. Gary Kain, the senior vice president of investments and capital markets, quit in January after receiving $3.7 million in 2008.

Among others who no longer work at the McLean, Virginia-based company, Kellermann earned $1.2 million in 2008, and Anthony "Buddy" Piszel, his predecessor, earned $909,051. Patricia Cook, former chief business officer, took home nearly $2 million, and Kirk Die, former auditor, earned $2.2 million.

David Moffett, who replaced Syron in September and resigned six months later, drew $283,269 of his $900,000 annual salary in 2008, plus $54,812 in other compensation. John Koskinen, who was non-executive chairman, replaced Moffett as interim CEO.

Kellermann, 41, and a 16-year veteran of Freddie Mac, played a key role in navigating past accounting troubles and answering queries of regulators and investors as the company struggled to extricate itself from the grips of the housing downturn. Just before his death, he told company officials he felt overwhelmed and was granted time off just before he died.

Of current executives, Bostrom earned a total $1.9 million in 2008, and George's compensation totaled $2.3 million.

Executives' pay includes no cash bonuses or incentive awards for 2008, the company said.

Follow Actions, Not Words

Fannie Mae and Freddie Mac have provided a painful lesson for investors in all financial stocks: During a crisis, take everything a firm says with a shaker-full of salt.

It shouldn't be surprising that executives will try to accentuate the positive, or at least play down the negative, given that financial firms live or die by retaining market confidence. How many times, after all, have financial firms said they have enough capital, only to turn around and raise more? Or said that the dividend is safe, just before cutting it.

Fannie and Freddie showed how high the stakes can be. And confidence is again center stage, with shares in firms like Lehman and Washington Mutual plunging Tuesday.

To defend themselves, investors should focus on the financial results a firm files with regulators according to generally accepted accounting principles, while giving far less credence to the non-GAAP measures firms often highlight.

The same caution should be applied to regulatory measures of financial strength. Those were, after all, what Fannie and Freddie pointed to for months in a bid to reassure investors that they were adequately capitalized.

Investors also should be on guard when it comes to measures of banking strength, such as Tier 1 capital, given that these involve a degree of management judgment. And, most important, investors should stick with management that acts, rather than talks.

By: David Reilly
Wall Street Journal; September 10, 2008

Housing's Biggest Woes Untreated

Rescue Won't Fix Falling Home Prices, Rising Foreclosures

The government takeover of Fannie Mae and Freddie Mac likely will help ease mortgage rates for home buyers, say economists, home builders and housing experts. But it won't cure the housing market's biggest ailments: falling home prices and rising foreclosures.

"This is another marginal step in the right direction," says Richard DeKaser, an economist at National City Corp., a large Cleveland bank. "But it doesn't resolve the glut of homes on the market or remove pressure on prices."

The housing market is stuck in a vicious cycle. It started with an oversupply of homes that eventually caused prices to plummet. Falling prices led to waves of foreclosures, as homeowners ran into problems refinancing their mortgages or selling their houses. Banks are reluctant to lend when home values keep sinking and defaults are rising, curbing housing demand further and fueling more price drops and defaults.

Investors and economists feared that a collapse of Fannie and Freddie would greatly exacerbate the downward spiral by essentially freezing the mortgage market. "The government's move takes that serious disruption to the financial market off the table," says Mark Zandi, chief economist at Moody's Economy.com.

Mr. Zandi says that while the takeover of the mortgage giants won't immediately stop the home-price slide, it should limit price declines to 5% to 10% over the next year, rather than the doomsday scenario of additional declines of 15% to 20% that some economists were predicting if Fannie and Freddie failed or pulled back dramatically.

"That's a big plus and means the financial system has gone a long way in writing down what it needs to," says Mr. Zandi, who until recently was among the housing market's biggest bears.

The most immediate change could come in the form of lower mortgage interest rates. They have remained relatively high -- above 6% -- for much of the past year amid credit-market troubles.

Among its many steps to shore up the mortgage market, Treasury is planning to buy Fannie- and Freddie-issued mortgage-backed securities from the market under a new program to help reduce the gap, or "spread," between yields on these securities and Treasury bonds. That should help lower interest rates on new home loans, making them more affordable for borrowers.

The higher spread means that investors perceive more risk in Fannie and Freddie's securities and therefore are demanding a higher premium in order to buy those securities. The cost of that higher premium can get passed along to the individual home buyer in the form of higher mortgage rates.

In early August, spreads on 30-year mortgage securities rose to 2.5 percentage points above Treasurys, close to their highs in March when worries about a marketwide meltdown were rampant. A year ago that spread was 1.6 percentage points, according to data from FTN Financial. Despite several rate cuts by the Federal Reserve in the past year, the interest rate on 30-year fixed-rate mortgages rose to 6.48% in August 2008 from 5.76% in January, according to Freddie data.

Lower mortgage rates may spur some new housing demand, but they won't likely alleviate buyers' concerns about home prices. "The takeover of Fannie and Freddie helps, but I don't think there will be a direct impact on stabilizing house prices," says Larry Sorsby, chief financial officer of Hovnanian Enterprises, a Red Bank, N.J., home builder, which reported its eighth consecutive quarterly loss last week.

Even amid Fannie and Freddie's recent turmoil, Mr. Sorsby says, most of his company's buyers who have decent credit scores, a job and a 5% down payment have been able to obtain mortgages, but the more marginal buyers -- a large segment of the potential home-buying public -- remain shut out of the market.

Mr. Sorsby and some economists doubt the newly bolstered mortgage companies will expand mortgage availability by loosening credit standards for subprime buyers.

Nor are lower mortgage rates expected to relieve many homeowners seeking to refinance their loans before their current rates reset at higher levels. Often, their biggest obstacle to refinancing is that their houses are worth less than their loan amounts or their credit profile is shoddy. The Federal Housing Administration is seeking to refinance such "underwater" borrowers facing resets, but its FHASecure program is aimed at families with strong credit histories, which could leave out many subprime borrowers.

By: Michael Corkery
Wall Street Journal; September 8, 2008

U.S. Seizes Mortgage Giants

Government Ousts CEOs of Fannie, Freddie; Promises Up to $200 Billion in Capital

In its most dramatic market intervention in years, the U.S. government seized two of the nation's largest financial companies, taking direct responsibility for firms that provide funding for around three-quarters of new home mortgages.

Treasury Secretary Henry Paulson announced plans Sunday to take control of troubled mortgage giants Fannie Mae and Freddie Mac and replace the companies' chief executives. The Treasury will acquire $1 billion of preferred shares in each company without providing immediate cash, and has pledged to provide as much as $200 billion to the companies as they cope with heavy losses on mortgage defaults. The Treasury's plan puts the two companies under a conservatorship, giving management control to their regulator, the Federal Housing Finance Agency, or FHFA.

With that, the U.S. mortgage crisis entered a new and uncharted phase, potentially saddling American taxpayers with billions of dollars in losses from home loans made by the private sector. Bush administration officials argued that the cost of doing nothing would be far greater because of the toll on the economy of falling home prices and defaults in the $11 trillion U.S. mortgage market.

Mr. Paulson noted that more than $5 trillion of debt and mortgage-backed securities issued by Fannie and Freddie is owned by central banks and other investors world-wide. "Failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Mr. Paulson said.

By taking this action, the government has seized control of the vast bulk of the secondary market for home mortgages and will have a more direct responsibility than ever for solving the housing crisis. The intervention also marks the failure of the public-private experiment that was created to boost home ownership among Americans. Fannie and Freddie were created by Congress to help prop up the housing market, and investors have long believed the government would bail the companies out in a crisis. But the companies have long been owned by private shareholders seeking to maximize profits.

The federal takeover was initially welcomed by banks and market watchers outside the U.S. who saw it as a way to dispel some of the uncertainty roiling the world's financial markets. The intervention could eventually be a boon for Wall Street, by providing a boost to the moribund mortgage industry and by perhaps diminishing the influence of Wall Street's two largest competitors in the market of packaging and reselling mortgage-backed bonds.

Markets across Asia rallied early Monday morning on the news, with financial shares leading the way. Japan's Nikkei Stock Average of 225 companies soared more than 3%, and Hong Kong's Hang Seng Index opened 4.5% higher.

The move is also likely to nudge down mortgage rates for consumers, who are facing the worst housing bust since the 1930s. Despite steep interest-rate cuts by the Federal Reserve, the cost of a typical 30-year fixed-rate mortgage has remained well over 6% for most of the past year. To bolster the mortgage market, Treasury said it will buy, on the open market, at least $5 billion of new mortgage-backed securities issued by Fannie and Freddie.

The government rescue of Fannie and Freddie is likely to leave a trail of billions of dollars in losses for stockholders, including some major banks. But it protects the investments of bondholders, including mutual funds, foreign central banks and government investment funds that own huge amounts of debt issued by the two companies. Investors that have loaded up recently on mortgage-backed bonds -- such as Pacific Investment Management Co., the large Newport Beach, Calif., bond manager -- could benefit as Treasury purchases of such securities drive up their values.

It is unclear how much the government's intervention will ultimately cost taxpayers. In addition to its initial acquisition of preferred shares, the government receives warrants giving it the right to a stake of 79.9% of each company for a nominal sum. The Treasury's preferred shares, which carry an annual dividend yield of 10%, will be senior to those earlier issued, meaning the government will have the first right to receive dividends.

Existing shareholders won't fare so well. The new overseers will eliminate dividends on billions of dollars of common and preferred stock, moves that are expected to further drive down the price of those shares. If the government exercises its warrants, existing common shares will be drastically diluted. Common shareholders are expected to see the value of their investment, which has already fallen, shrivel further, say analysts. Even preferred stockholders are expected to see a significant decline.

That prospect is especially problematic for some of the commercial banks and thrifts that hold high concentrations of Fannie and Freddie preferred shares. The Office of Thrift Supervision, a government agency that supervises savings and loans, said that roughly 2% of the 829 companies it regulates -- or around 17 banks -- had a concentration in common or preferred shares of Fannie Mae and Freddie Mac that surpassed 10% of their Tier 1 capital. Regulators said Sunday they would work with banks that hold large exposures to Fannie and Freddie "to develop capital-restoration plans" if necessary.

The Shape of the Future

The Treasury's move doesn't answer the question of what ultimately happens to Fannie and Freddie. Under the conservatorship of their regulator, the companies will still have their shares listed on the New York Stock Exchange. But management control goes to the regulator until it deems the companies financially healthy. Congress ultimately will have to decide in what form Fannie and Freddie will be relaunched or whether they will be replaced by different types of entities.

Mr. Paulson signaled that he wants to remake the U.S. housing-finance system in the longer term, ditching the "flawed business model" of government-sponsored enterprises like Fannie and Freddie. The Treasury plan limits the size of each company's mortgage portfolios to a maximum of $850 billion as of the end of 2009. (Fannie currently owns about $758 billion of mortgages and related securities, while Freddie's total is about $798 billion.) After that, the Treasury intends for the mortgage holdings to shrink about 10% a year until they reach about $250 billion at each company.

Wrangling over the future shape of Freddie and Fannie will likely be kicked to the next Congress. Already the majority Democrats are pushing back on elements of Treasury's plan. "Good luck on that," said Massachusetts Rep. Barney Frank, chairman of the House Financial Services Committee, when asked about the Treasury's plan to start reducing the firms' portfolios beginning in 2010. Mr. Frank called it "more of a sop to the right" than a real policy prescription and said it wasn't going to happen.

Many economists and analysts believe the government had to wade deeper into the mortgage market because for now "private markets are just not willing to put up the capital" for home mortgages at prices U.S. consumers could afford, said Susan Wachter, a professor of real estate and finance at the University of Pennsylvania's Wharton School. Without government support for the mortgage market, home prices would fall much further, exposing the country as a whole to greater economic strain, Ms. Wachter says.

The turn of events for Fannie and Freddie is remarkable considering the two companies for so long shunned the riskiest type of mortgages, only to embrace those mortgages late in the game in an effort to regain market share from Wall Street rivals.

As early as 2005, Fannie executives publicly expressed concerns about growing risks in the mortgage market. In May of that year, Thomas Lund, a Fannie Mae executive vice president, said that lenders should be concerned if borrowers straining to afford homes were given loans allowing for low payments in the early years but storing up much higher ones for later. "In many cases the consumers may not understand all the risks," he said.

Yet both companies expanded their exposure to riskier loans. At both Fannie and Freddie, so-called Alt-A loans, a category between prime and subprime, accounted for roughly 50% of credit losses in the second quarter, even though such loans accounted for only about 10% of the companies' business. Alt-A mortgages include loans made with less than full documentation of borrowers' income or assets.

As these and other loans -- including many in areas such as California and Florida that are among the hardest hit by the housing crisis -- started to go bad, the companies failed to raise enough capital late last year, when investors were still fairly bullish on their prospects, to see them through the current storm. The companies have recorded combined losses totaling about $14 billion over the past four quarters, eating deeply into their meager capital holdings. Most analysts expect them to report sizable losses for at least another couple of years as the costs of foreclosures mount.

A Reflection of the Market

Fannie and Freddie's credit problems are largely a reflection of the overall weakness in the housing market. Some 9.2% of mortgages on one- to four-family homes were at least a month overdue or in the foreclosure process in the second quarter, according to the latest survey of the Mortgage Bankers Association. That is the highest percentage in the 39 years that the trade group has been doing the surveys.

"Make no mistake, anybody in the mortgage business is going to see much higher losses than they thought they would a year ago because we've had the worst housing market and the largest home price declines that anybody has seen," said Thomas Lawler, a housing economist in Leesburg, Va., who formerly worked for Fannie.

Both companies are also exposed to some of the mortgage industry's most troubled players. Countrywide Financial Corp., now part of Bank of America Corp., was the largest provider of loans purchased by Fannie Mae, accounting for 29% of its business in 2007, according to Inside Mortgage Finance, and was the second largest source of loans for Freddie Mac, with a 16% share. IndyMac Financial Corp., which previously had focused its business on Alt-A loans that didn't meet Fannie and Freddie guidelines, switched to a policy of making loans that could meet their standards in 2007. IndyMac was taken over by the Federal Deposit Insurance Corp. this summer.

At Fannie, Herb Allison, who formerly served as chairman of the investment company TIAA-CREF, succeeds Daniel Mudd. Freddie's chief executive, Richard Syron, was succeeded by David Moffett, who has been vice chairman and chief financial officer of U.S. Bancorp.

Potentially, Mr. Syron could walk away with an exit package totaling as much as $15 million, said David Schmidt, a senior consultant at James F. Reda & Associates LLC, a compensation consulting concern in New York. That includes a pension and deferred compensation, about $3.7 million in severance pay and a possible payment of $8.8 million to compensate for forfeiting recent equity grants. A Freddie spokesman said Mr. Syron had said he doesn't "anticipate receiving nearly that much."

Mr. Mudd's exit package, including stock he already owns, could total $14 million, Mr. Schmidt estimates. That includes $5 million in pension and deferred compensation, $4.2 million in severance pay and $3.4 million of restricted stock, based on Friday's closing price. The value of that stock could fall sharply, however.

By: James Hagerty, Ruth Simon & Damian Paletta
Wall Street Journal; September 8, 2008