Daily Briefing Weekend Edition

Industry Awaits New GSE Direction

By Brian Collins and Paul Muolo

The future of the secondary market lay in the balance last week as the mortgage industry collectively wondered what will follow the government's historic takeover of congressionally chartered mortgage giants, Fannie Mae and Freddie Mac.

As National Mortgage News went to press, it was "business as usual" between seller/servicers and Fannie and Freddie - but with the government squarely backing their combined mortgage investments and guarantees of $5.2 trillion.

The government guarantee that was once deemed "implicit" was made explicit by the Treasury Department, which means the U.S. taxpayers are on the hook for any potential losses.

Industry executives interviewed by this newspaper were expecting - at the very least - lower guarantee and delivery fees but were not sure when that might come.

Meanwhile, seller/servicers large and small and industry vendors were left scratching their heads, wondering what the GSEs might look like five years down the road after being in a conservatorship (and restructured) or possibly eliminated altogether. "We all knew this day would come," said Rudy Orman, a former Goldman Sachs executive who now works for an investment fund that bottom fishes in delinquent loans. "So now what? Coke and Pepsi are dead or are they?"

Mr. Orman's former employer, Household Finance, was a charter member of FM Watch, a lobbying group whose mission it was to check the expansionist tendencies of the GSEs.

One Wall Street veteran, requesting anonymity, who has worked in mortgages for three decades, predicted that in time the two would be combined into one and given a mission of focusing on providing liquidity only to low- and moderate-income Americans. He added, "We're going back to full-doc and income verification," he said. "I can live with that."

The future of Fannie and Freddie will be decided by the next Congress working in tandem with a new White House.

The beginning of the end for the two came early Sunday morning, Sept 7. (NMN sent out a special e-mail report on the takeover and its implications late that morning.)

That Sunday the new GSE regulatory agency, with Treasury's blessing, officially placed the congressionally chartered Fannie and Freddie into separate conservatorships - with the government committing $100 billion to each.

In tandem with the takeover, FHFA removed their CEOs, laying the groundwork for a radical and historic restructuring of the entire U.S. mortgage market.

Specifically, FHFA dismissed Fannie CEO Daniel Mudd and Freddie chairman and CEO Richard Syron. The two men will remain on in transition roles. Herb Allison, a former vice chairman at Merrill Lynch, was named CEO of Fannie, and David Moffet, former vice chairman of U.S. Bancorp, will lead Freddie.

As part of the GSE restructuring plan, Treasury is providing capital and funding support in an effort to boost investor confidence in the two's debt. The agency has committed to purchase new Fannie and Freddie MBS, a move that will add liquidity to the mortgage bond market. It's expected Treasury will purchase $5 billion worth of agency MBS in September alone. "The primary mission of these enterprises now will be to increase the availability of mortgage finance," said Treasury secretary Henry Paulson.

FHFA director James Lockhart placed the GSEs in conservatorships due to their ailing financial condition and their deteriorating ability to support the mortgage market.

According to company figures compiled by this newspaper, Fannie owns just shy of $400 billion in subprime and alt-A bonds/loans, Freddie about $300 billion. Delinquencies on these "nonconforming" loans were accelerating and threatened to swamp their capital base.

Secretary Paulson made conservatorship a prerequisite for providing the two GSEs with quarterly capital infusions to ensure they maintain a positive net worth. "I support the director's decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs," Mr. Paulson told reporters that Sunday morning.

In agreeing to a conservatorship, the GSEs each issued $1 billion in senior preferred stock to Treasury. With each capital infusion, Treasury will accumulate more preferred stock. Treasury also will be issued warrants that give the agency the right to purchase 79.9% of the common shares in each GSE.

Meanwhile, the government-sponsored enterprises can increase their MBS purchases by about $100 billion each. But the investment portfolios are capped at $850 billion through 2009.

The senior preferred stock covenants also require the GSEs to reduce their portfolios by 10% a year starting in 2010 until the portfolios reach $250 billion.

The new conservatorships will not pay dividends on common or preferred stock. The Treasury secretary advised banks and thrifts with large exposures to GSE common and preferred shares to work their regulator in developing a capital restoration plan.

Late last week, the FHFA and the GSEs' new CEOs were trying to assure Fannie and Freddie managers and employees (who have seen the value of their stock options evaporate) that their jobs are safe and that they should stay on. Retention plans were being discussed. Mr. Mudd and Mr. Syron will walk away with million-dollar severance packages, which is already drawing fire from Capitol Hill.

One thing is for certain: the mortgage industry of the past two decades - one where most residential loans were sold to Fannie and Freddie, and Wall Street - is on the road to extinction.