The federal government's efforts to bolster mortgage giants Fannie Mae and Freddie Mac could result in added support for landmark housing legislation that includes several significant bond provisions, sources said yesterday.

Legislation that would be the vehicle for new regulatory authority over Fannie Mae and Freddie Mac as proposed by federal officials over the weekend, making it more likely Congress will pass, and President George W. Bush will sign, the measure whose future was previously the subject of a veto threat.

The bill, which Friday passed the Senate, now returns to the House for consideration of the new measures.

Senate Banking Committee chairman Christopher Dodd, D-Conn., yesterday said he hoped to get the legislation passed this week. The bill, which calls for $300 billion in mortgage relief and increases the limit on mortgage revenue bonds, exempts interest on housing bonds from the alternative minimun tax, would give the Federal Reserve authority to regulate capital requirements for the government-sponsored enterprises, Fannie Mae and Freddie Mac.

According to observers, the new provisions make the bill more likely to pass, which increases chances that another of its provisions, allowing Council of Federal Home Loan Banks to extend letters of credit to member banks for tax-exempt bonds, would also become law.

The FHLB provision could help improve access to credit enhancement in the municipal market. The measure initially received a tepid veto threat from the White House, but the need for GSE legislation will push the housing bill through intact, said Peter Knight, director of government relations for FHLBank Pittsburgh.

The legislation enables the FHLBs to provide standby letters of credit through the 8,100 member banks without triggering a loss of the tax exemption of the issuers' bonds, Knight said in an interview Monday.

"We expect that will be in any final legislation," he said.

The legislation would help issuers like hospitals and utilities the most, Knight said, because of the downgrades to a number of traditional bond insurers, which have driven up the cost of bond insurance and bank liquidity. The insurers today are not as willing to engage in small-scale deals, he said, and the guarantees from home loan banks will bring additional competition to the market.

"Any additional guarantors are welcome to the market," said Matt Fabian, managing director for the Municipal Market Advisors in Concord, Mass. "The market is strapped for enhancement."
But Fabian said the FHLB guarantees still has issues to overcome. Banks may become risk-averse and decide not to back bonds. He said guarantees might take a year to become active. But the development is still positive for the market.

"Things that are double- and triple-A rated trade much better," Fabian said. "They have much better liquidity and with liquidity so thin in the market as much enhancement as possible is appreciated."

The Senate passed its version of the housing bill Friday, but on Sunday, Treasury Secretary Henry Paulson issued three provisions to ease market panic concerning the GSEs. He called on Congress to give the Federal Reserve "a consultative role" in setting capital requirements and other standards for the GSEs.

Paulson also said the Treasury opened the Fed's discount window to the two companies allowing them to borrow directly from the government at same 2.25% as commercial banks. Paulson also said the Treasury would "purchase equity" in either GSE if needed.

Dodd said he received the legislative proposals from the Treasury Monday afternoon that would extend statutory authority over the GSEs through Dec. 31, 2009. Dodd also said Paulson and SEC chairman Christopher Cox will join Federal Reserve Board chairman Ben Bernanke's scheduled testimony before the Banking Committee Tuesday.

House Financial Services Committee chairman Barney Frank, D-Mass., said the House version will include Paulson's proposals, but did not specify when it would be voted on.

The two largest U.S. mortgage guarantors in June when RealtyTrac reported foreclosures increased 48% in May. Fannie and Freddie Mac together guarantee about $5 trillion in U.S. mortgages. The surge in foreclosures has forced the GSEs to finance more and more mortgages depleting their cash reserves.

Last Monday, a Lehman Brothers report said Freddie and Fannie would need to raise $29 billion and $46 billion, respectively, causing sell-off in the companies' stock throughout the week. Shares in the two companies dropped almost 50% last week.

But as stock tumbled, the municipal markets remained calm. The muni market has essentially decoupled from Fannie and Freddie since 2006 when the two limited their muni purchasing.
Fannie Mae completely halted its purchases of muni bonds in May 2005 after it bumped up against the 2% de minimis tax rule. The rule is a "safe harbor" provision, under which corporations must have no more than 2% of their assets in tax-exempt bonds in order to be able to avoid having to prove to the Treasury that they are not trying to write off their cost of borrowing to buy tax-exempt bonds.

"The impact has been nil," said New York State Housing Finance Agency president Priscilla Almodovar.

"The bondholders - Thursday, Friday and going on into today - were really taking all this in stride," she said.

However, in a research note to clients Monday, Merrill Lynch analysts warned that for some pre-refunded bonds may be backed by tax-exempt GSEs, and not U.S. Treasuries, making them a riskier holding.

"As always, investors should be clear as to the structure of their bonds and which type of backing their pre-res have in their escrows," analysts wrote in the report.

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