Fannie Mae and Freddie Mac—the Congressionally chartered mortgage giants that provide liquidity for 70% of all residential loans funded in the U.S.—are done. They have no friends in Congress and Republicans (and plenty of Democrats) blame them for creating the housing bubble.

Even their regulator at the Federal Housing Finance Agency, Ed DeMarco, thinks they have no future. Otherwise, he would never have pulled their shares off the New York Stock Exchange while refusing to answer questions about a reverse stock split. (It worked for AIG. Why not the GSEs?)

In six months the White House is scheduled to release its plan on what to do with Fannie and Freddie with a nod toward creating a housing finance system for the 21st century. All eyes will be on the Obama administration, which is already being tarred and feathered by bankers who expect to see their future earnings snipped by 20% or so thanks to the new regulatory reform bill. (If you think that piece of legislation was contentious, wait until you see GSE reform. I'm sure there are plenty of banks that would like to see the value of their GSE preferred stock come back to them in full.)

It might be said that the Fannie/Freddie "question" looms on the horizon, not unlike the BP oil slick, waiting to reach land and destroy what it hasn't already. And you can pretty much guess that in the fall, the GSEs will be part of a political litmus test where politicians running for office try to prove how tough they tried to be on FanFred in the past, but were blocked by housing liberals, read: Democrats.

It's easy to kick the GSEs when they're down. After all, unlike the auto companies, AIG and the megabanks, the billions Fannie and Freddie have received to maintain a positive net worth position won't eventually be recouped by Uncle Sam, at least it sure doesn't look that way. But while it's easy to stick your thumb in their eyes, a central question needs to be addressed: If the two eventually disappear, which firms will fill the void? At last check, Fannie and Freddie had a combined balance sheet of $1.6 trillion, mostly whole loans and MBS. They guarantee $5.5 trillion in residential product, or 55% of all housing debt in the U.S. If they go away, who takes their place?

It's not a disingenuous question. As mortgage MBS co-inventor Lewis Ranieri once quipped, "Mortgages are about math." You can't replace $1.6 trillion of balance sheet capacity overnight. In fact, you can't replace it within three years either. Those assets must reside somewhere. And if you think that our nation's megabanks, the regionals and what's left of the thrifts and credit unions will gladly sweep in to fill the void you're mistaken.

The profit margin between a residential lender's cost of funds and the yield on the mortgages they write is quite strong right now and looks to stay that way for 12 to 18 months, maybe even longer. The yield on the 10-year Treasury is in the basement but so is a lender's cost of funds. (When's the last time you checked CD rates?) But all this doesn't mean that it's safe for a depository to borrow short (deposit accounts) and lend long (30-year fixed-rate loans.) Actually, an argument might be made that borrowing short and lending long is a heck of a lot safer than anyone really thinks, but that doesn't mean banks will do it or their regulators will it. If you recall your financial services history, the S&L crisis was caused by borrowing short and lending long (followed by unfettered asset deregulation).

But getting back to Fannie and Freddie. The balance sheet issue is only one part of the equation. It's likely the White House and Congress will allow for some type of successor GSE, mandating that the institution have a small balance sheet for mortgage products that are less liquid. As for whether that GSE will be "on balance" for budget deficit calculations, that's a different matter. If you put the GSEs' guarantees "on budget" the potential obligations of the U.S. government just increased by $5.2 trillion. Our creditors may have something to say about that. Or maybe not.

But the guarantees on Fannie/Freddie MBS are a key issue because they account for half of all consumer housing debt. If a covered bond market for housing debt replaces the GSEs the issue of balance sheet capacity for the issuing commercial banks doesn't go away. Holding residential mortgage assets still requires capital. One former Fannie Mae executive suggested to me that a new housing GSE could issue MBS guarantees and the money would be set aside in an insurance fund. "It would function like deposit insurance," he said.

One thing the government is not likely to do is fire sale Fannie and Freddie's assets, namely their MBS. If they do, it would cause MBS prices to crater while creating massive mark-to-market losses at banks, thrifts, insurance companies, pension funds, take your pick. The one asset the government could sell is their automated underwriting systems, Loan Prospector and Desktop Underwriter.

Technology consultant Jeff Lebowitz estimates that revenue at DU and LP averages $200 million to $250 million a year. "You could sell them for one to two times revenue more or less," he said. Of course, the money raised would be a drop in the bucket compared to the $140 billion Treasury has pumped into the two. Yes, Fannie and Freddie are done, politically speaking. But for now, they are here to stay.

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