Mortgage Bank

If you were Fannie Mae or Freddie Mac how would you answer the various news stories which question your financial health?

FHALoanPros.com has obtained the letter below. It’s a response by Peter Federico, Freddie Mac’s senior vice president of asset and liability management, to recent news coverage in the Wall Street Journal and offers a perspective which does not seem to be getting much attention.

The points made are important because with few facts, little balance and great haste we are quickly moving toward the nationalization of both Fannie Mae and Freddie Mac. Before this happens it might be good to consider the consequences — both intended and otherwise — that are likely to emerge from the take-over of either company.

Right now we have a functioning secondary market that buys local loans, packages them and then sells mortgage-backed securities to investors worldwide. Fannie Mae and Freddie Mac are crucial to the secondary market, disable one or both companies, have them taken over by federal stewards, and the result could be a smaller secondary marketplace, one that buys far fewer local mortgages.

If you want to see home values shudder and fall, if you want to see the value of your house tank, then damaging the secondary market would certainly accomplish that task, especially now when the National Association of Realtors says existing home prices in June fell 6.1 percent from a year ago and loan applications are down 34 percent from a year earlier according to the Mortgage Bankers Association.

Mr. Federico’s letter is below:

Freddie Mac and The Wall Street Journal agree on at least one thing: our successful $3 billion debt auction on August 19 demonstrates we are able to fund ourselves. But while the Journal sees the results of the auction as a sign that Freddie Mac is in poor health, the facts instead suggest quite the opposite.

The housing market is in terrible condition, with default and credit loss rates not seen since the Great Depression. Throughout the past year, much of the mortgage market has either shut down or is operating at a fraction of its capacity as most mortgage investors have fled the market. The one part of the market that continues to operate well is the conventional conforming market served by Freddie Mac and Fannie Mae. Throughout the crisis, Freddie Mac has fulfilled our mission of providing liquidity and support to the market, purchasing nearly $300 billion in mortgages during the first half of 2008 alone.

Freddie Mac, of course, is not immune to the problems in the mortgage market. Like other companies involved in residential mortgage lending and investing, we have reported losses. But our mortgage default and charge off rates are a fraction of industry averages. We continue to maintain capital above regulatory requirements. Our mortgage guarantee and investment businesses are experiencing strong revenue growth –- with net interest income in the second quarter up more than 90 percent. And contrary to the Journal’s story, we have a strong liquidity position with continued access to the debt markets.

Our August 19 debt auction of 5-year notes was priced to yield 4.172 percent, or 113 basis points above yields on Treasury notes. This was the highest spread Freddie Mac has had to pay on such debt. The Journal interpreted this as indicating a loss of confidence in Freddie Mac.

But the Journal failed to consider that spreads to Treasuries have widened on all securities, and often by a much higher amount. For example, spreads on securities issued by AA-rated financial companies have risen from around 50 basis points in early 2007 to more than 300 basis points in April 2008 and about 250 basis points today. It is not surprising that spreads to Treasuries on all kinds of securities are rising, given the turmoil in financial markets and the resulting flight to Treasuries by many investors.

Consider these facts, as well as that the offering was oversubscribed at a time of both high market volatility and generally slow summer activity in the markets. Consider also that a few hours later, when the issue was freed to trade, the spread narrowed 5 basis points – a vast move in a market typically known for swings of 1 to 2 basis points. Based on all these facts, an objective observer would likely conclude that Freddie Mac is in a much healthier financial position than the Journal would have one believe.

The Journal also suggested that rising debt borrowing costs for Freddie Mac and Fannie Mae’s could lead to higher mortgage rates for consumers and prolong the housing slump. In fact, mortgage rates are affected by a variety of factors, and primarily by pricing of credit risk. While mortgage rates have risen in recent months, they remain near historic lows. For example, rates on 30-year fixed-rate loans currently are about 6.5 percent, according to Freddie Mac’s Primary Mortgage Market Survey. That is lower than the average annual 30-year rates in 32 of the prior 37 years.

It may make good copy to portray Freddie Mac as losing the confidence of investors and thus raising mortgage rates for borrowers. But in truth, agency debt investors know we are still “money good” –- and we continue to pump billions of dollars in liquidity into a housing market that badly needs us.

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