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New Fannie mae and Freddie mac limits may speed up purchase of delinquent loans

New Fannie and Freddie limits may speed up government loan modification program

When the Treasury Department took over Fannie and Freddie, one of the requirements they set for the companies required them to begin shrinking their portfolios of mortgages and related investments, which total a combined $1.5 trillion.

The idea was to rein in the companies’ size and growth.

But just recently, the Treasury eased that requirement, meaning the companies won’t be forced to sell mortgages next year into an already weak market and could even buy mortgages on the market, which could help hold down interest rates.

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The Treasury also suspended for the next three years the $400 billion cap on the bailout subsidy that the government will offer. That could give them more flexibility to modify mortgages without worrying about taking losses.

Mahesh Swaminathan, senior mortgage analyst at Credit Suisse, said the firms could use their increased capacity to purchase delinquent loans from pools of mortgage-backed securities that they guarantee.

Fannie and Freddie already purchase defaulted loans as they modify them under the administration’s loan-modification program, but the additional breathing room means it is now a “slam-dunk for them to speed up” purchases of delinquent loans, Mr. Swaminathan said.

New accounting rules that take effect in 2010 also could make it more cost-effective for the companies to buy out bad loans and keep them in their investment portfolios.

The relaxed portfolio limits calmed investor worries that Fannie and Freddie would be forced to sell some of their mortgage holdings just as the Federal Reserve was preparing to wind down its purchases of mortgage-backed securities next spring.

The Fed’s commitment to buy up to $1.25 trillion has helped to keep mortgage rates near record lows; without that support some economists have said rates could rise to 6% by the end of 2010.

Although Fannie’s and Freddie’s core business is their role guaranteeing payments to mortgage investors, for years they earned additional profits and generated controversy by maintaining a large investment portfolio filled with mortgages and related securities.

Removing caps could help with more expensive loan modifications

The most controversial part of the 2009 Christmas Eve announcement was the decision to erase any caps on the amount of Treasury money that the firms can take. That gives the mortgage-finance companies and their government masters a much freer hand to respond to the housing crisis in the year ahead, possibly by moving more aggressively to modify troubled loans.

Some analysts said the companies now have greater flexibility to pursue more expensive loan modifications, including by writing down loan balances, which would have generated losses, requiring more government cash. But without a bailout ceiling, the administration “needs no longer worry that anything they do would drive Fannie or Freddie over the edge into negative net worth,” said Ms. Petrou.

A Treasury representative said the bailout caps were suspended “specifically to ensure continued confidence in Fannie Mae and Freddie Mac, but were not based on any considerations” related to an expansion of the administration’s loan-modification program.

The Treasury already has handed over about $112 billion to help shore up the companies, which were among the first big financial institutions to fall under government control in the wake of the nation’s mortgage crisis.

Fannie and Freddie are playing a crucial role in providing mortgage liquidity. They own or guarantee half of the nation’s $11 trillion in home mortgages and together with the Federal Housing Administration are responsible for backing nearly nine in 10 mortgages.

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