The importance of Fannie Mae and Freddie Mac not only to the U.S. mortgage market but to the worldwide economy was demonstrated last week when the U.S. Treasury Department put the two GSEs under conservatorship.

As FTN Financial analysts aptly put it, "If anyone was under the impression that the financial marketplace is not truly globally integrated, the actions by the U.S. Treasury Department to put Fannie Mae and Freddie Mac into conservatorship has shattered that impression."

FTN went on to add that not only is the U.S. government focusing on primary rates via a plan to actively buy new-issue RMBS, but it has also become vital that such an announcement be made around noon U.S. time on a Sunday.

This is simply because international investors - who own the senior debt and the RMBS guaranteed by the two agencies - are watching. According to FTN, these buyers hold roughly 30% of the debt and 15% of the RMBS.

There's no doubt about it, the world was watching, specifically - and as many commentators noted - the Chinese government, which supposedly put the pressure on Treasury Secretary Henry Paulson to push GSE reform.

Observers said that one of the underlying reasons for the Treasury's action was that the GSEs were starting to go against their intended purpose in working to preserve their own financial well-being.

"The GSEs were working to conserve capital by shrinking their retained portfolios, increasing their guarantee fees and tightening their underwriting standards - which were all negative for the housing market because they made it more expensive and difficult to obtain a mortgage," Arthur Frank, head of mortgage research at Deutsche Bank Securities said.

Frank also said that with the conservatorship in place, the GSEs can, at least until 2009, grow their portfolio to a minimum $850 billion, which runs in contrast to the path both Fannie Mae and Freddie Mac had been running.

Furthermore, the Treasury Department through its mortgage purchase program can, depending on market conditions, start buying MBS when spreads start to widen.

The Treasury's move creates bright spots in the presently bleak market environment. "This is a huge positive for agency MBS, while it will likely modestly help the U.S. housing market," Frank said.

In related research, Merrill Lynch analysts said that although Treasury rates might rise because of this development, mortgage rates will almost certainly fall lower. Lower mortgage rates and looser underwriting standards, they said, will have various positive effects, including an increase in available credit and affordability. It will also help some borrowers to reduce their payments through refinancing.

"The government plan could both increase demand for homes while reducing supply by diminishing the risk of foreclosure," Merrill analysts wrote.

However, the Merrill analysts said that many headwinds still face the housing sector, such as high inventories, underwater borrowers - many of whom can not afford their monthly payments - and rising unemployment.

Furthermore, Merrill cited Secretary Paulson's comments urging Congress to use the coming 18 months to permanently address the structural issues presented by the GSEs, suggesting that there are basically two alternatives available. One is that government support would be explicit, the other that it would be "nonexistent."

Merrill noted that if the government opts for privatization, that decision will carry issues to be addressed. The TBA market, for one, depends on the interchangeable nature of pools, which runs counter to a situation where the agencies function as private bond insurers. Also, the agency market has remained relatively stable throughout the crisis, even though non-agencies faltered.

Right now, the market is in a wait-and-see mode. Yes, government efforts to fix the housing problem will bring unintended consequences, but everyone seems about ready to take the bad for the greater good.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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