Expect a Charter 'Move' By the GSEs in Near Future

Fannie Mae chairman Franklin Raines knows he has a good thing going. So does his counterpart over at Freddie Mac, Leland Brendsel. Both men know the mortgage business like the backs of their hands and they know - probably better than anyone - just how valuable it is having a government charter.

Valuable indeed. Last year, Freddie Mac earned (net) $5.7 billion, Fannie Mae $4.6 billion. When it comes to "operating" earnings, Fannie, which is larger than Freddie, outearned its closest competitor $6.3 billion to $3.8 billion.

When you add up the numbers, the two together earned $10.1 billion or $10.3 billion, depending on which type of accounting you subscribe to. "GAAP" or "operating," either way, it's a heck-of-a-lot of money - money that General Electric, American General, Wells Fargo and J.P. Morgan wouldn't mind getting their mitts on. In fact, that's why these four are still charter members of FM Watch, a group whose goal in life is to "contain" the charter creep of Fannie & Freddie. If you think that FM Watch is really concerned about the possibility of a taxpayer bailout of the GSEs, I have some Enron bonds I'd like to sell you.

Yes, the stated goal of FM Watch is "charter creep," but as most industry veterans know, these four horsemen of the "Mortgage Apocalypse" wouldn't mind having a piece of Fannie and Freddie's business. (Household is the fifth charter member, but its new owners are rumored to be contemplating bolting the group.) And yes, Fannie and Freddie wouldn't mind having bits and pieces of their businesses, too, mortgage insurance being the lowest piece of hanging fruit.

At a recent investor conference, Mr. Raines (in response to a question) hinted that the mortgage giant might one day relinquish its government charter - but only if the positives outweighed the negatives, and only if it were in the best interest of the company's shareholders. The big question, of course, is when will that day come.

Both Fannie and Freddie regularly weigh the benefits of their government charters and neither have come seriously close to turning in their "eagles," though sometime in the early 1990s then Fannie Mae chairman David O. Maxwell toyed with the idea before his top lieutenant Jim Johnson talked him out of it.

Wall Street analysts as well as GSE competitors (the FM Watch bunch and their silent allies) know that some day Fannie and/or Freddie will give up the government charter. And if they don't give it up, chances are their attorneys and lobbyists will find a way to expand it, allowing them to enter new business lines.

New business lines, though, could lead to out-and-out intra-industry bloodshed, and chances are that if Fannie or Freddie go this route it will be in a move to enter housing finance markets outside the U.S. Keep in mind that the GSE charter is so broadly written (and vaguely worded) that Fannie and Freddie can do many things as long as it results in increasing liquidity in the secondary market, and promoting "access to mortgage credit" throughout the nation.

Just so you know, the way the charters now read, Fannie and Freddie cannot originate loans directly to the consumer and they cannot provide liquidity to mortgage markets outside the U.S.

Why would Fannie and/or Freddie give up the charter when the eagle provides them with a printing press to print money? Currently, Fannie has a total book-of-business (outstanding MBS plus portfolio) of $1.89 trillion. Freddie's book-of-business is about $1.29 trillion. Together, that adds up to $3.18 trillion. Total housing debt in the U.S. is about $6.3 trillion, which means the two together have a 50% market share, more or less.

If the housing debt market (outstandings, as in money borrowed that is secured by a one- to four-family residence) grows at an annual rate of 7% to 8% and Fannie's book-of-business is growing at an annual rate of 25%, you can figure that eventually, Fannie will run out fishing line. Freddie's portfolio and book is growing at a rate slower than Fannie's, which is curious and notable. Does Freddie see something out there that Fannie doesn't?

Regardless, in time, one of the two will make a charter move, probably within five years. What exactly that move will involve, I don't know. It may entail a complete relinquishment of the charter or some type of change that would allow one of the firms to enter new business lines or markets while keeping some portion of the charter.

Politically speaking, chucking the charter would be easier than trying to maneuver the charter. But rest assured, the day is coming. How do I know this? When I was younger I did a bit of fishing, salt water mostly, and learned early on that if you run out of fishing line there are two courses of action: reel it in or cut the line. Which do you think Fannie or Freddie would choose?

Paul Muolo is executive editor of both Mortgage Servicing News and National Mortgage News. He can be e-mailed at: Paul.MuoloThomsonMedia.com.

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