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Five Questions: Time to Unify Fannie, Freddie Securities?

blogs.wsj.comJuly 2, 2012

By Nick Timiraos

Freddie Mac is facing a new problem as it nears the fourth anniversary of its government takeover: Investors are spurning its mortgage security in favor of its sibling, Fannie Mae.

To address that problem, calls are mounting within the industry for the mortgage giants’ federal regulator to move the companies towards trading on a common security. The American Securitization Forum, a trade group, is set to release on Monday a white paper endorsing such an effort.

Tom Deutsch, the group’s executive director, said that taking technical steps to make Fannie’s and Freddie’s mortgage bonds more homogenous could eliminate the pricing problems that have been plaguing Freddie Mac—there’s plenty more on how that could work in the paper. Freddie Mac and its regulator, the Federal Housing Finance Agency, declined to comment on any such plans.

Banks don’t keep most of the mortgages that they make. Instead, they sell them to investors—these days, primarily Fannie and Freddie—which package them together and sell them off as mortgage-backed securities.

Here’s a closer look at what’s happening:

Didn’t the government already deal with this when it took Fannie and Freddie over? Not really. The companies were taken over by the government nearly four years ago because they were about to run out of capital. The government has injected tens of billions in taxpayer aid to keep them solvent so that mortgage markets run smoothly.
But the companies are still functioning separate entities, and they issue their own securities—in the same way that two countries might issue their own currencies.

What’s the latest problem? Freddie Mac’s mortgage securities have for more than a decade traded at a slight discount to Fannie. While the price gap is a fraction of a cent, that translates into a few million dollars in lost revenue when banks and other lenders sell $1 billion of mortgages to Freddie. To make up the gap, Freddie offers certain concessions and payments. “Freddie has to pay sellers for their discounted securities,” said David Stevens, the chief executive of the Mortgage Bankers Association, who has also called for moving to a single security. As a result, Freddie generates less revenue than it otherwise could.

If this has always been a concern, why does anything need to be done right now? Over the last six months, the gap between the pricing on Freddie’s securities has worsened relative to Fannie’s. That caused Freddie’s market share to drop in several months. And if Freddie has to take more aggressive steps to close that gap by offering more generous concessions to originators, “ultimately, this is costing taxpayers money in the form of greater subsidies to Freddie Mac,” said Mr. Deutsch.

At a certain point, the risk is that Freddie Mac falls below “whatever may be a critical mass of business” to keep spreads in line with the competition, said Richard Dorfman, who oversees securitization for the Securities Industry and Financial Markets Association.

What triggered spreads to widen? It’s not entirely clear. Typically, Freddie has been able to use its mortgage portfolio to purchase certain securities, helping to shore up prices. But Fannie and Freddie are being forced to shrink those portfolios, and the firms’ federal regulator has instructed the firms not to use their portfolios to support those securities prices.

So why does this matter to borrowers? Mortgage-backed securities ultimately result in the interest rate that consumers pay for mortgages. “We should care because it imposes some potential cost on taxpayers,” said Steven Abrahams, a mortgage research analyst at Deutsche Bank. “It’s a measurable, material inefficiency in the cost of mortgage funds to homeowners.”

Corrections & Amplifications: Richard Dorfman oversees securitization for the Securities Industry and Financial Markets Association. An earlier version of this post omitted the word “industry” in the group’s name.

Back to July 2012 Archive

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