Yikes! It was a bull stampede through the markets all day Monday, and cordial Housing Doom antagonist Bill Maloni was in the thick of it. The electrons had barely cooled down on his call to unleash the GSEs  when Fannie Mae’s stock went nuts following a WSJ report   that the company was formally asking for a bump up in its portfolio limit. By the end of the day Fannie had rocketed up 10 percent, with Freddie not far behind. For both big GSEs, the daily increases were the biggest in years. Mr. Market affirmed Bill’s viewpoint fast and hard. If nothing else, this has got to be the blogosphere post timing achievement of the month!
But are relaxed portfolio limits a good idea? This blogger has serious reservations. Peter Wallison’s old team of financial analysts at the neo-con American Enterprise Institute studied GSE retained portfolios for several years, and my distinct impression is that their conclusion that they’d grown too large and should be curtailed had merit. Fannie’s debt position compares to a good sized European country’s and the sum total of GSE assets isn’t too different in magnitude from America’s public debt. Indeed international markets regard F&F’s senior bonds to be practically equivalent to treasuries, although the government insists this "agency debt" is not backed by the full faith and credit of the US. Something like a Reader’s Digest version of the AEI findings is a regular feature of speeches by James Lockhart, Maloni nemesis and head of OFHEO, the present regulator of the top two GSEs.
The chaotic state of Fannie’s financials is a case for concern — and optimism. On the one hand, the company has less than 5 months before a New York Stock Exchange deadline to file their ’06 10-K annual report with the SEC or face delisting. On the other, interim CFO Bob Blakely may well be America’s number one financial troubleshooter. He is confidently expecting to meet that deadline. He is probably the one person who could confirm whether Fannie’s financial state could stand the strain of an increased portfolio. It’s unthinkable that the company would have approached OFHEO for the boost without Blakely’s blessing, so one must assume that he judges the project to be possible.
One reason Fannie’s retained portfolio in particular gives me nightmares like the old Sci Fi horror movie The Blob is because it may well constitute the world’s largest stack of off-balance-sheet assets. As Calculated Risk blogger Tanta has just described in her post "SFAS 140: Like A Bridge Over Troubled Bong Water," such deals are coming under increasing scrutiny in the mortgage finance sector. This is the principle reason I firmly hold that the new GSE regulator must be mandated to carefully monitor systemic risk. I am distressed that there hasn’t been more debate on the Bean-Neugebauer amendment, that proposes to strip this necessary direction from the new regulator.
The GSEs don’t just do AAA-rated agency debt. Will some of the bump be financed in their subordinated debt? That stuff isn’t covered by Congress’s implicit guarantee, and as I noted in yesterday’s post, the Fed is working hard to remove that too-big-to-fail guarantee that backs risk in the subordinated debt space.
And speaking of AAA debt, those bond ratings are beginning to look a bit different from the same letter grades with corporate ratings. In view of recent events, the ratings agencies are just starting to tighten up their standards. That’s yet another thing to watch out for, especially if the retained portfolios will end up with more high rated tranches of subprime and Alt-A securities as a result of the boost.
Yes a world where Fannie and Freddie start buying more mortgages is going to be a brighter one for the originators. We must be careful not to destabilize the Enterprises or the larger economy while we’re doing this, though.
Notes and References: "FREE "THE FANNIE AND FREDDIE TWO," NOW!", by Bill Maloni, MaloniGSE, August 6, 2007. : "Fannie, Freddie Shares Rise on Talk of Portfolio Cap Increase", by Jody Shenn and James Tyson, Bloomberg, August 6, 2007. : "Fannie Mae Wants Higher Mortgage Cap", by Marcy Gordon, AP / Forbes, August 6, 2007. : "Fitch tightens criteria for mortgage bond ratings", Reuters, August 6, 2007.