Fed Heading Towards Mortgage Market Exits. GSEs Need Explicit Government Guarantee First

by devteam January 15th, 2010 | Share

Yesterday in the process of discussing the Fed's eventual exit from the TBA MBS market, I explained that the first step to a smooth withdrawal was a much needed EXPLICT US GOVERNMENT GUARANTEE on Fannie Mae and Freddie Mac mortgage-backed securities.

“Given the already weak outlook for loan originations in 2010, itrnsounds like its going to take a major downturn in housing for the Fedrnto extend the MBS Purchase Program. One thing is for sure though, inrnorder for the MBS market to continue providing funding for loanrnoriginators, the US government will have to EXPLICITLY guarantee agencyrnMBS cash flow investments….By explicit guarantee I mean there is a line item on the Federal Budget that allocates funding for Agency MBS guarantees”

Many people believe, because the GSEs were placed into conservatorship in 2008, that Fannie and Freddie MBS cash flows were already explicitly guaranteed by the US government. This is NOT THE CASE.

From the Fannie Mae MBS prospectus:

“Wernguarantee to the MBS trust that we will supplement amounts received byrnthe MBS trust as required to permit timely payments of principal andrninterest on the certificates. We alone are responsible for makingrnpayments under our guaranty. The certificates and payments of principalrnand interest on the certificates are not guaranteed by the United States and do not constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae.”

While that statement is pretty clear, there is still much confusion surrounding the status of GSE MBS cash flow guarantees. This confusion arose mostly because, in their baseline budget projections, the CBO accounted for the cost of the entities' operations as if they were being conducted by a federal agency.   To be very clear, in the baseline budget projection published on August 25, 2009 , the CBO treated mortgages owned or guaranteed by Fannie Mae and Freddie Mac as being loans or guarantees of the US government.

CBO's budget projections give the Congress a baseline against which to measure the effects of proposed changes in tax and spending laws. The CBO was PLANNING on the GSE's becoming a federal entity. Unfortunately the CBO does not make that decision, the Administration's Office of Management and Budget does by adding them to the Federal Budget.

The below statement is taken from a CBO report, released yesterday, titled CBO’s Budgetary Treatment of Fannie Mae and Freddie Mac.

The Administration has taken a different approach to recording thernimpact of Fannie Mae and Freddie Mac on the federal budget. Inrnconjunction with the conservatorship,the Treasury signed agreementsrnwith the two entities intended to ensure that they could continue tornsupport the mortgage market. In exchange for making direct cashrninfusions into the entities, the Treasury received shares of theirrnpreferred stock and warrants to purchase their common stock. ThernAdministration’s Office of Management and Budget (OMB) continues torntreat Fannie Mae and Freddie Mac as outside the budget, and it recordsrnand projects outlays equal to the amount of those cash infusions. As arnresult, the Administration has not included in its budget figuresrnsubsidy costs that would be directly comparable to CBO’s $291 billionrnestimate of such costs in 2009

Plain and Simple:GSE MBS cash flows are not EXPLICITLY GUARANTEED. They will not be EXPLICTLY GUARANTEED until thernAdministration's Office of Management and Budget adds them to thernFederal Budget. Just because the CBO accounted for the GSE's as federalrndebt in ther projections does not mean the GSEs actually fall under the US government'srnfiscal responsibility.

Last night the CBO released this on their blog:

“CBO believes—consistent with the principles outlined in the 1967 Report of the President’s Commission on Budget Concepts—that it is appropriate and useful to policymakers to account for and display the entities’ financial transactions alongside other federal activities.”


Yesterday afternoon this flashed across my newsfeed:


Larry Summers is the Director of the President Obama's National Economic Council by the way…

This leads me back to what I wrote yesterday regarding the Fed's eventual exit from the mortgage market. Before the Fed can make any decisions on the MBS Purchase Program, GSE mortgage-backed securities must have an EXPLICIT GUARANTEE from the federal government…without it the Fed will be forced to stay in the mortgage market until another plan is proposed. This can only happen if the Office of Management and Budget adds the GSEs to the President's Budget.

THIS PROCESS IS IN THE WORKS…if the OMB does add the GSEs to the Federal Budget (there will be a lot of political outcries if that happens btw), it will be the beginnings of the Fed making a move towards the mortgage market exits.

We expect President Obama to release his FY2011 budget shortly after the first State of Union Address in late January/early February. We'll have a much clear indication of things to come once we see what the OMB does with the GSEs on the Federal Budget. WAIT AND SEE…

By the way I am not saying this is the right plan, I'm just pointing out that it is a possibility.

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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