Outlook 2011: Lawmakers likely to delay decision on future of Fannie Mae, Freddie Mac: observers

By Kenneth Lim

Boston, Dec. 31 - Lawmakers are likely to delay making any major decision on the future of Fannie Mae and Freddie Mac in 2011, market analysts and traders said.

The U.S. Treasury is expected to announce on Jan. 31 a proposal to address the future of Fannie Mae and Freddie Mac, which have been under federal conservatorship since September 2008. The Obama administration had already kicked the can down the road in February 2010 when it said only that it would continue to assess the situation. The administration organized a conference on the topic in August 2010 to gather opinions, but the widespread view in the market is that the can will be kicked again in 2011.

"Political gridlock is likely to delay GSE reform far into the future: the houses of Congress will likely be divided at least until the 2012 elections, and Democrats and Republicans have a vast difference in opinion on the future of housing finance," wrote Barclays Capital's agencies research team of Rajiv Setia and James Ma in a report.

A number of options have been bandied around the markets. The U.S. government could place the two government-sponsored enterprises' bad debts into "bad banks" that are backed by the government, leaving behind "good banks" with clean balance sheets to privately continue the mandate of Fannie Mae and Freddie Mac.

The government could also do away with Fannie Mae and Freddie Mac, honoring their existing debts but no longer issuing any new paper. Their roles in supporting U.S. homeownership will then be taken on by another system.

In all likelihood, lawmakers and regulators will continue to ponder the issue and leave the agencies alone for as long as they can, said Mike Goldman, head of agency trading at Guggenheim Partners.

"I remain in the camp that we're not going to see any major resolution in 2011," he said. "The reality is that the housing market needs the government's support. The less being said, the less pressure being put on the housing market."

Decision makers are being forced to tread carefully because the U.S. housing market remains fragile, and ill-conceived policies and remarks run the risk of sending the economy into another slide, Goldman said.

Do no harm

"If you do anything that's going to weaken the support for the housing market, you're going to mess with the economic recovery," he said. "I think anything that makes Freddie Mac and Fannie Mae safer weakens the housing market, by definition."

The government's investment in Fannie Mae and Freddie Mac as part of the conservatorship is also "doing fine," drawing 10% every year under the Preferred Stock Purchase Agreements, so there is little need for quick changes, Goldman added.

Indeed, the Barclays analysts reckon that the amount of capital that Fannie Mae and Freddie Mac need to draw from the Treasury, in other words the additional cost of federal support, is already tapering off. The amount that the Treasury has set aside for both agencies should be "more than sufficient," the analysts wrote.

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, added that "the current structure of government capital injection is pretty effective."

Political headwinds blowing

Lawmakers also face tremendous inertia against taking action because "Fannie Mae and Freddie Mac are the only source of liquidity in the mortgage market now, and as long as Fannie Mae and Freddie Mac remain the only source, there's no way to run them off," LeBas said.

Market participants are also wary of any drastic action.

"Every bank in the U.S. has a massive amount of Fannie Mae and Freddie Mac obligations," LeBas said.

All things considered, LeBas expects that the administration will probably push back the timeline for making a decision, to closer to the end of 2011 or start of 2012.

Goldman said the government may have to present something more concrete before its current support runs out.

"The next critical deadline is December 2012, when the current PSPAs expire," he said.

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