The regulator of Fannie Mae and Freddie Mac offered lawmakers a interesting behind-the-scenes look at the collapse of the two secondary lenders as independent companies.
| James B. Lockhart III, director of the Federal Housing Finance Agency, testified today before the House Committee on Financial Services on the Conservatorship of Fannie Mae and Freddie Mac.
FHFA was created as the regulator of the two government sponsored enterprises under H.R. 3221, The Housing and Economic Recovery Act of 2008, which was signed into law by President Bush on July 30. The agency additionally regulates the Federal Home Loan Banks, which are also GSEs. By the second quarter of this year, Fannie had reported losses of nearly $10 billion over the prior 12 months. Freddie’s reported losses during that same period were nearly $5 billion. During July and last month, published reports began circulating about the solvency of Fannie and Freddie, Lockhart said, according to a transcript of his prepared testimony. The reports centered on the two firms’ need to raise capital as well as their accounting practices, ability to continue to borrow and possible government bailouts. |
James B. Lockhart III |
Their ratings were being dramatically cut by the ratings agencies — boosting their cost of borrowing, while shares of both companies tumbled. At the same time, housing prices were falling and mortgage market conditions were deteriorating.
Central banks halted their purchases of Fannie’s and Freddie’s securities and began selling them. Lockhart noted even small sales triggered large price moves.
Internal supervisory reviews and market activity had FHFA worried about the soundness of the two secondary lenders.
Both companies were relying on short-term discount notes to finance 30-year mortgages. What few debt securities that were issued had maturities of no more than three years.
As long-term debt financing was drying up, they faced $89 billion in long-term debt maturing in the second half of 2008.
Paralyzed, Fannie and Freddie began raising fees and tightening credit standards. At the same time, wider credit spreads were increasing the cost of mortgages — disabling them from fulfilling their missions of providing capital to the mortgage market.
After all other efforts failed, both companies reported to FHFA and to the Treasury that they could no longer access capital markets to bolster their capital positions without Treasury financing.
“Importantly, key developments in July and August demonstrated market recognition of these heightened credit concerns and the effect of the deteriorating market environment on the enterprises,” Lockhart testified. “New equity capital in any meaningful size became unavailable, and yields on enterprise debt and MBS rose relative to other benchmarks.
“These developments convinced us that the time to act was now.”
The regulator noted one alternative was to cease new business and unload assets in crippled market. But such a move would have pushed mortgage rates higher and crushed securities prices.
On Sunday, Aug. 7, 2008, the Federal National Mortgage Association, more commonly known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, which does business as Freddie Mac, were placed into conservatorship by FHFA.
“It was the most prudent regulatory action to take,” Lockhart stated.
The companies will receive financial assistance from the Treasury during the next 15 months. Their portfolios will be allowed to grow to $850 billion, then be reduced by 10 percent per year.
Both firms’ chief executive officers and chairmen were ousted — losing severance payments in the process — and replacements were brought in at significantly lower compensation. In addition, stock dividends were eliminated.
“I am pleased to say that the enterprises’ funding costs and the spreads on MBS have declined,” the director said. “This lower cost has been passed on to homebuyers, with 30-year fixed-rate mortgage rates below 6 percent for the first time since January.”
