Here's a pop quiz for European financial institutions that own stock in US mortgage giant Fannie Mae: How much has the company's share price appreciated over the past three years? If you answered zero go to the head of the class.
Yes, investors in Fannie Mae stock are not a happy bunch. Fannie's share price has gone nowhere the past three years and chances are it will go nowhere in the future. Why? Two reasons. The first is politics, or what some analysts in the mortgage industry call political risk. This translates into a central question – will the US Congress pass laws or regulations that will hurt how Fannie Mae and its sister company, Freddie Mac, conduct their business of buying residential loans in the secondary market?
As this issue of Mortgage Strategy went to press a key Senate panel had just passed legislation that would create a strong independent regulator for Fannie, Freddie, and another government sponsored housing enterprise called the Federal Home Loan Bank system (a 12-bank regional co-operative that also buys mortgages). However, the White House felt the bill wasn't strong enough because the regulator would not have full receivership powers in the event these mortgage giants went bust and needed to be liquidated. The sticking point in the bill was language that gave Congress power of veto over a liquidation.
That's right, Congress could actually prevent Fannie and/or Freddie from being sold in the event either went bust. The White House shot down the language believing it would not achieve the administration's goal of creating what it calls a 'world class' regulator for Fannie, Freddie, and the FHLB system.
The legislative language raises a big theoretical issue – liquidation. If Fannie and Freddie are so financially strong and omnipotent why won't these two government-sponsored enterprises and their allies in the trade associations call off their lobby dogs and get a bill passed?
If they have plenty of cash, receivership is really a non-issue, right? Who says receivership will ever be needed? Is there something to be afraid of in regard to Fannie and Freddie that we don't know about? If there is nothing to fear, give receivership powers to the regulator and to the regulator only. Don't make it even more political by giving Congress veto power.
But that's not what happened in Washington. The Senate Banking Committee passed a bill and the White House, the next day, bad-mouthed it in public, effectively killing it for the year. There could be a compromise but this being an election year, few think any sort of GSE bill will pass.
The public face of opposition to a bill has centred mostly on Fannie Mae. Embroiled in a $5bn accounting scandal, Freddie Mac has kept its mouth shut, at least publicly, letting Fannie's lobbyists carry the heavy water. (Freddie's top inhouse lobbyist recently left the company under investigation by Federal officials about how he accounted for some of the fund-raiser dinners he paid for).
But let's get back to Fannie. The second reason Fannie's stock price is likely to go nowhere anytime soon (it's been hovering at $74) has to do with a forensic audit its current regulator, the Office of Federal Housing Enterprise Oversight, is conducting. A few hours before the Senate took up the bill OFHEO laid a bombshell on Fannie, saying publicly that the company may have to restate prior years' earnings.
Specifically, OFHEO told the world that Fannie may not have “applied the proper accounting” in regard to impairment charges (writedowns) on its investments in manufactured housing loans and other assets. Manufactured housing loans is nice talk for trailer park loans of which Fannie owns $8bn worth. Last year the mortgage giant took a $155m 'other than temporary' impairment charge on the portfolio. It keeps arguing that its manufactured housing loans are fine.
Stateside, Fannie is trying its best to play down OFHEO's proclamation on its earnings. A Fannie Mae spokeswoman stressed that OFHEO “has not reached any conclusions” in regard to an audit of its accounting policies and procedures.
OFHEO's opinion on a possible earnings restatement was contained in a press release on Fannie and Freddie's capital conditions. The release said in the fourth quarter Fannie exceeded its minimum capital requirement by $2.89bn (Freddie exceeded its by $9.05bn). Now $2.89bn sounds like a lot of money – a nice cash cushion. But keep in mind that Fannie boasts onbalance sheet assets of $880bn.
Let's get back to Freddie for a second. Last year Freddie re-stated prior year earnings upwards by $5bn. The belief in the industry is that Freddie has been a lot more skillful (and conservative) than Fannie in managing its portfolio.
Industry executives think that if Fannie is forced to restate it might not be a Freddie Mac-like upward restatement but a downward revision. The big question – by how much? And would such a revision put Fannie below its minimum capital requirement?
Right now, nobody is saying (for the record at least) that Fannie is facing a downward revision. But folks are worried, especially investors. Keep in mind that these two giants are the lynchpins of the US mortgage market. Fannie's stock price has gone nowhere for three years. Its debt continues to trade nicely but what will happen to those same stock and debt investors (Europeans as well as US) if OFHEO forces Fannie into a negative earnings restatement surprise? Which brings us back to the Senate bill and liquidation powers. If there is no chance of a regulator ever needing liquidation powers then why not give these to the regulator without Congress having a power of veto? It's a question that nobody here has answered.
Based in Washington DC, Paul Muolo is executive editor of National Mortgage News and a contributing editor to Mortgage Strategy