In a move to restore confidence in the U.S. mortgage market, President George W. Bush signed into law on July 30th, a housing rescue bill that includes a provision for the U.S. Treasury Secretary to inject capital into Government Sponsored Enterprises (GSEs) through direct stock or debt purchases.. The birth of the so called “Housing and Economic Recovery Act of 2008” removed a major element of market anxiety over the fate of the GSEs, namely Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLBs). While details of the new law remain sketchy, we believe it reinforces our view that the credit quality of the GSEs’ debt is equivalent to that of the federal government, short of an explicit full faith and credit pledge. Furthermore, we think the new legislation may have been the most significant development to date in the government’s efforts to stabilize the housing and capital markets and to put the economy on track towards recovery.
Off -balance-sheet Vehicles of USA.gov
Established by the Congress in 1938 to provide liquidity in the mortgage market, the Federal National Mortgage Association (Fannie Mae) was converted in 1968 from government ownership to a federally chartered, stockholder-owned private corporation. The Federal Home Loan Mortgage Corporation (Freddie Mac) was created in 1970 as a stockholder-owned corporation with a similar mission to Fannie Mae’s. The two firms’ mortgage “books of business,” including direct mortgage holdings and those guaranteed by them, currently amount to $5.2 trillion, or roughly half of the US mortgage market.
Congress passed the Federal Home Loan Bank Act in 1932 to revitalize the thrift industry after the Great Depression. The FHLB System is comprised of its Board and 12 regional banks, each of which is owned by its member institutions including savings and loans, commercial banks and credit unions. Unlike Fannie and Freddie, the FHLBs do not guarantee or buy mortgage loans, but rather provide short-term “advances” to member institutions with mortgage loans as collateral. The FHLBs currently have $1.2 trillion advances outstanding.
The GSEs, particularly the shareholder-owned Fannie and Freddie, have always been the subjects of criticism. As privately chartered corporations with a public mission, the companies are considered quasi-government entities whose debt obligations are implicitly supported by the federal government. Commercial lenders decry their lower funding costs as an unfair competitive advantage. Conservative politicians point to potential burdens to the taxpayers should one of them fail. Strong lobbying efforts by the GSEs and top level politicians at the firms’ helms have also raised eyebrows over the years. Finally, the mortgage boom and the subsequent reversal of mortgage credit resulted in a recent cascade of media reports covering the “I told you so” crowd that had been critical of the GSEs.
In retrospect, it is not hard to make the case that the GSEs are essentially the off -balance sheet vehicles of the federal government, similar to commercial bank affiliates such as the various asset-backed commercial paper programs that have made recent headlines. The government wanted to fulfill its public mission of lowering funding costs without committing to it its own balance sheet. The charters have been able to give mortgage lenders and debt investors the impression that the government is behind the GSE programs while no specific federal dollars were committed. Depending on which direction the political winds have blown, federal officials have tacitly acknowledged, vehemently denied, or wholeheartedly advocated the federal government’s backing of the mortgage giants. In the end, just as the banks had to lend their own balance sheets to support off -the-books ABCP in stressful times, this new legislation represents the government’s commitment to lend its own credit to support the GSEs.
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