The Secretary of Treasury, along withthe Federal Housing Finance Agency (FHFA) announced that it has taken control of Fannie Mae and Freddie Mac.


The government is placing both GSEs under conservatorship, and as a result, will replace the chief executive officers and the boards of directors of each company.


Through this conservatorship, the Treasury will ensure that these agenciesmaintain a positive net worth by injecting capital as needed. The Treasury has also established a liquidity facility enabling the GSEs to borrow money through collateralized loans.


Under the conservatorship, Fannie Mae and Freddie Mac will also be allowed to increase their portfolios until the end of 2009 up to a maximum amount of $850 billion each. More importantly, the Treasury will purchase MBS until the end of 2009 for as long as spreads stay wide.


This new version of the two GSEs will re-address their current risk based pricing, focusing on affordability.


Meanwhile, Merrill Lynch analysts said that they expect that agency MBS spreads should tighten considerably over the next few days while they also expectagency debt spreads to tighten sharply. It not clear, according to analysts, whether these will tighten more or less than agency MBS.

In a just released report, Barclays Capital analysts said that they believe that most credit market participants fully expected that the U.S. government would not let the GSEs fail.


Considering that these agencies play a key role in the mortgage market, the absolute size of their outstanding debt, as well as the makeup of the holders in their debt, Barclays said that these factors placed the agencies on the upper end of the “too big too fail” spectrum. However, certain questions regarding the timing, scope and form of the eventual government intervention have occupied investors and weighed considerably on sentiment and risk aversion. Barclays said that finally the uncertainty on three key issues has now been resolved.


Barclays said that considering the near-consensus view that some type of GSE government intervention was needed, uncertainty about the timing was definitely weighing on investors. The firm said that the sooner the government acted, the better, particularly given market concerns that a real solution would have to wait until the next administration took office in 2009. Considering this, the developments over the weekend are a positive for the market in terms of timing.

In short, analysts believe that the steps taken over the weekend are a positive for the credit market. They thinks that the resolution of uncertainty regarding the timing and the ambitious scope of the proposals will outweigh any concerns surrounding capital structure and the fallout from dropping preferred valuations.


But, supporting the GSEs only addresses one aspect of the issues confronting the housing market, ensuring continued availability of conforming mortgages and Barclays analysts think stress caused by falling home prices and illiquidity in nonconforming mortgages will continue to have negative implications for the market, Barclays said. 

Merrill said that although Treasury rates may rise,  mortgage rates will almost certainly be lower, Merrill said. Lower mortgage rates and looser underwriting standards will have various positive effects such as increase the availability of credit, improve affordability, as well as help some borrowers reduce their payments through refinancing.

This should reduce foreclosures and increase demand for housing. But, Merrill said there are still many headwinds facing the housing sector such as high inventories, underwater borrowers, many of whom could not afford their monthly payments, and rising unemployment.


Merrill added that premiums and IOs should under-perform lower coupons and POs as prepayments rise, underwriting standards ease, and seriously delinquent loans are bought out (the practice had been halted due to capital constraints).


In specified pools, Merrill said that easing of lending standards should cause loan balance to outperform credit-impaired bonds as incentive may trump ability to prepay. GNMA/FNMA swaps should dip and start to flatten out across coupons. FHLMC Gold/Fannie swaps should rise as the extra Freddie Mac concerns eliminated. Agency hybrids, CMOs, and dwarfs are probably going to lag in the initial tightening. Non-agency mortgage prices may also rise as prepay forecasts increase, according to Merrill.

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