The Federal Reserve announced on Sunday that it had authorized the Federal Reserve Bank of New York to lend directly to both Fannie Mae and Freddie Mac if it becomes necessary for the bank to do so.
According to the Fed, lending would be at the primary credit rate and will also be collateralized by federal agency and Treasury securities.
In a report released this morning by Barclays Capital, analysts noted that the two GSEs combined have over a $1 trillion in unencumbered securities.
The analysts added that this measure alone should "put to rest any worries about rollover risk in the near term."
They added that these facilities might be in place for at least 18 months, although, for all intents and purposes, they will be in place as long as necessary, particularly if markets stay turbulent.
Barclays said that this measure was essential before markets opened Monday to stop any possibility of a "run on the bank." Also, this step did not require legislative approval.
Analysts said that as might be expected, in exchange for the privilege of borrowing at the discount window, the Fed will now have a consultative role in making prudential standards and capital requirements for the both agencies. This has longer-term implications for the GSE business model, according to analysts.
The U.S. Department of the Treasury also indicated that it is looking for Congressional approval to for the meantime raise the Fannie's and Freddie's line of credit, which is now at $2.25 billion. What the new limit will be is still unclear, but Barclays thinks that this added line of credit will also be in place for 18 months.
According to Barclays, considering the access to the Fed window, the increase in the line of credit was really unnecessary. But, Barclays said that getting Congress' approval symbolically reinforces these agencies' links to the government from a symbolic perspective, and is probably going to put to ease any worries among foreign central banks as well as other buyers with regards to the senior debt is "money good."
The implicit guarantee lives on, said Barclays analysts, and they feel that the GSEs are so intertwined in the fabric of global capital markets that a failure would cause not just a U.S. recession, but a global depression as well.
Meanwhile, the Department of the Treasury is also looking for authority for a temporary equity infusion into the firms, if needed. The potential size of the infusion and its terms with respect to the rest of the capital structure remain unclear.
Both of the Treasury's moves are probably going to be inserted into the Housing Bill that is making its way through Congress, analysts said. Furthermore, they are likely to be "swiftly approved" by the end of the week, Barclays said citing press reports
Analysts believe that the GSEs needed access to both funding and capital. For example, they said that even as government officials said that Fannie Mae and Freddie Mac were capitalized adequately, even though the GSEs look to be vulnerable to losing funding.
In the same way, just opening up the Fed window to these entities without offering capital, would be like putting a "band-aid on the problem,'" said analysts."The fact remains that future credit losses are likely to be sizeable, and the only way for the GSEs to offset these losses is via growth of the top line, which in turn, requires a substantial amount of capital."
Barclays added that the government's moves have now put in place contingency measures for both funding and capital. As a practical matter, the government has also gone well beyond what many expected, and Barclays believes that it should be commended. they think that the sentiment regarding the GSEs to improve dramatically tomorrow.
"Ultimately, what the GSEs needed was a bridge loan," wrote analsyts. "The government is essentially guaranteeing one will be available regardless of market sentiment. Moreover, with the viability of the GSEs no longer in question, the public markets may now very well open up to them again, possibly making a huge government infusion of equity unnecessary. "
Analysts think that the GSEs' share prices to react very favorably to this news near term. Longer term, they expect GSE capital requirements to rise. The size of the portfolio business is also potentially open to debate. However, analysts do not expect much change in the business model near term. According to analysts, with banks' capital constrained, the government needs the GSEs to keep purchasing mortgage-backeds to shore up secondary market spreads.
They said that the current market capitalization of the GSEs was basically signaling impending insolvency. Barclays believes that the intrinsic value of these businesses is much more, even given how onerous the new capital regime might be for the portfolio business.
Debt spreads had already tightened considerably on Friday on expectations of a rescue, Barclays noted. While spreads may continue to tighten as a knee jerk reaction, with the GSE model likely to persist, longer term, it would not be surprising to see spreads give back some of their recent gains, Barclays said. However, in the near term, they would not get in the way of spreads as they ratchet tighter on the view that the "implicit" guarantee is now almost plainly "explicit".
Analysts also expect sub-debt spreads to also react very favorably to these moves, and CDS spreads should also react favorably. Considering that GSE equity is not being crushed in a bailout of debtholders, the positive sentiment should spill over to financial stocks in general.
This morning the Office of Federal Housing Enterprise Oversight (OFHEO) Director James Lockhart said, I congratulate and thank Chairman Dodd, Ranking Member Shelby and the Senate for passing a sound and comprehensive GSE regulatory reform bill. He added that this bill should, "help restore confidence in the housing markets by creating, on passage, a new, stronger regulator with all the necessary tools to oversee Fannie Mae, Freddie Mac and the Federal Home Loan Banks. I am hopeful the House will act quickly and the bill will soon be enacted into law."
"With this very turbulent market it is important to strengthen the regulator of Fannie Mae and Freddie Mac and combine it with the regulator of the Federal Home Loan Banks as soon as possible as all of these GSEs are being asked to do more and more to support the mortgage market," Lockhart said.
Meanwhile, the American Securitization Forum today issued the following statement: We support the steps taken today by Treasury Secretary Paulson and the Federal Reserve, and note the importance of restoring investor confidence as a key to ensuring that affordable mortgage credit is available to all Americans.