NEW YORK/WASHINGTON (Reuters) - Steps proposed by U.S. authorities to shore up Fannie Mae FNM.N and Freddie Mac FRE.N could keep the mortgage finance companies alive but may mean their days as reliable profit-growth machines are over.
Under the deal ironed out between policymakers and Fannie and Freddie, the Federal Reserve will have a new “consultative role” in determining how the two set their capital levels and “other prudential standards.”
In the past, the profit-making engine for each company had been the income generated on portfolios of mortgage holdings which have a combined balance of more than $1.5 trillion. But if Fannie Mae and Freddie Mac get new mandates to hold larger capital reserves to protect against losses, the companies would deliver smaller returns to investors.
“Their earnings will return but at much lower return-on-equity” for shareholders, said Robert Napoli, an analyst at Piper Jaffray in Chicago. “I think they’ll be forced to hold more capital than in the past.”
As government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac have a federal regulator that sets their capital standards. The Office of Federal Housing Enterprise Oversight has argued for years that they need more power to demand that Fannie Mae and Freddie Mac build a bigger capital cushion.
Congress has long wrestled with the question about how best to determine capital levels and lawmakers, who must ratify the weekend emergency plan, are balking.
“I‘m just uneasy with what we are trying to achieve here,” Senator Christopher Dodd, chairman of the Senate Banking Committee told Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke at a Tuesday hearing.
Paulson told Dodd that the regulators were “bootstrapping” the emergency provision onto existing reform legislation could cause problems. The intent of the varying measures might be at odds since some of the proposals could hamstring the housing lenders at a time when a credit crunch is hurting borrowers.
For years, Fannie Mae and Freddie Mac have counted on their allies in the housing market to fight off legislation that could curb their business. In the wake of the current crisis, though, some of those friends are rethinking their position.
“I don’t think there is a question anymore that the regulators need to look at their portfolios,” said Jerry Howard, chief executive of the National Association of Home Builders.
Bernanke told lawmakers on Tuesday that he did not want to hold “veto power” over capital standards set by a GSE regulator but that any new Fed authority should be considered in light of a Treasury blueprint that would extend Fed oversight of the financial services sector.
Whatever regulatory role the Fed wins for itself, it will have more power at the end of the current crisis than it did at the beginning, said Alex Pollock, of the conservative American Enterprise Institute think-tank in Washington.
“If you look at the history of the Fed, whether their policy was correct or mistaken, they have continued to accumulate power,” said Pollock.
Regulatory pressure to increase capital would create a sea change to the rapid growth strategies championed by former chief executives Franklin Raines and Leland Brendsel. Under their watch, Fannie Mae and Freddie Mac portfolios more than doubled from 1999 to 2003, and profits followed.
Slower revenue growth from portfolios would make it tougher for the companies to offset losses, which have summed to more than $11 billion since last June.
In the midst of a housing finance crisis, regulators might not want to tinker right now with Fannie Mae and Freddie Mac when they are financing more than half of today’s fresh home purchases. They are seen by analysts as “the only game in town” for mortgage funding as investors turn their backs on Wall Street-funded programs.
“We do not expect much change in the business model near term. With banks’ capital constrained, the government needs the GSEs to keep buying (mortgages),” according to analysts at Barclay Capital, which nonetheless expects higher capital requirements and possibly smaller portfolios.
And even some GSE critics are skeptical that the new Fed oversight will force the companies to trim their investment.
“This is just window-dressing,” said Peter Wallison, a fellow at the American Enterprise Institute, who has long warned that Fannie Mae and Freddie Mac present a systemic risk to the world economy.
Reporting by Patrick Rucker in Washington and Al Yoon in New York; Editing by Richard Satran