The indispensability of Fannie and Freddie: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

LONDON (Reuters) - Like it or not, the U.S. economy and financial system just can't live without mortgage behemoths Fannie Mae and Freddie Mac, who are now pretty much all that is standing in the way of a complete collapse in housing.

Concerns over how suggested new accounting rules might force the two government-sponsored entities (GSE) to raise huge and unfeasible amounts of capital touched off a rapid fall in their shares, their bonds and in the mortgage debt they guarantee this week, not to mention in the rest of the U.S. stock market.

Treasury Secretary Henry Paulson and James Lockhart, Fannie and Freddie's main U.S. regulator, both moved to allay concerns, and much of the market damage was unwound.

No wonder. If you consider what the world would look like if they ran into very serious trouble you quickly realize that they are not just too big to fail, but pretty much too everything to fail.

"With the private label market for mortgages still non-functioning (Fannie and Freddie) offer the only liquidity and bid for mortgages in this market, other than bank and thrift balance sheets," Keefe, Bruyette & Woods analyst Frederick Cannon wrote in a note to clients.

And indeed, thrift and bank balance sheets aren't what they used to be, impaired as they are by their own losses on everything from structured finance to leveraged loans to housing related debt.

"The U.S. government ... in our opinion, will continue to stand by the GSEs in the current market to provide a level of support for home ownership and liquidity for housing," Canon said.

This is the crucial point. Banks are making fewer loans, and on tighter terms, while the securitization market that formerly funded large loans, subprime loans and others is gone. Fannie and Freddie now fund 8 out of every 10 loans in the United States below the $417,000 level, according to regulatory data. By March, Fannie and Freddie accounted for 97.6 percent of the mortgage bond market, compared with less than 50 percent in the first quarter of 2007, according to UBS.

And even with them continuing to lend, housing in the United States is falling rapidly in value, further eroding bank balance sheets and raising questions about the government-sponsored lenders' own capital levels. Pending sales of previously owned homes fell by 4.7 percent in May compared to April, far more than expected and down 14 percent from a year before.

Were tough new capital raising requirements put on Fannie and Freddie, as some suggested, they might well cut back on their own funding of loans, thereby accelerating the fall in housing. I have a hard time seeing that being allowed to happen. Both firms have more capital than is required by their regulators, as they have been at pains to point out.

LENDERS OF LAST RESORT

Fannie and Freddie carry an implicit, or more to the point commonly assumed, guarantee from the U.S. government. That allows them to fund for less than their non government-sponsored rivals, and quite frankly is the only reason they've been able to continue to lend as they have into the maelstrom of the U.S. credit and housing downturns.

Which is more or less what they were created to do, having been designed in part to stave off the fierce regional credit crunches that used to happen when banks were hit by local downturns.

To be sure, Fannie and Freddie are operating in an extremely difficult market. They've raised billions in new capital, suffered billions in losses and it's fair to expect that there is plenty more of that to come.