Treasury Secretary Henry Paulson was right when he said that the GSEs' "continued strength is important to maintaining the confidence and stability in our financial system and our financial markets," since their debt is held by financial institutions worldwide.

In other words, Fannie Mae and Freddie Mac are not Bear Stearns - their influence and reach are so much bigger than that.

And we are not talking pennies here. It's about $1.3 trillion in outstanding U.S. agency debt.

Arthur Frank, head of mortgage research at Deutsche Bank Securities, captured the essence of it when he said: "In the eyes of international investors, a default in GSE senior debt or MBS would be seen as virtually a default of the United States government. This is why it's impossible for the government not to stand behind GSE senior debt and MBS."

The urgency to support the GSEs became even more apparent with the failure of IndyMac Bank - the second largest bank failure in this country's history - Frank said.

The chain of events that followed IndyMac's failure is not coincidental. IndyMac happened right before Paulson announced that the Treasury would seek authority to increase the line of credit to the GSEs and buy equity if necessary, inevitably tying the U.S. government more closely to the fate of these two mortgage giants.

There's a lot of speculation about what will happen if the government becomes more closely aligned with the agencies. A Merrill Lynch report said that the GSEs' charter might be adjusted to allow these agencies to underwrite streamlined refinances of underwater loans, which are mortgages where the loan balance is greater than the value of the house.

There's also the possibility that the government would push Fannie and Freddie to restart their delinquent loan buy-out program, allowing loans to be modified prior to homeowners entering foreclosure.

But, no matter what the outcome is, GSE links to the government are getting stronger.

The macro economic implications of a Fannie/Freddie collapse are enormous, but there's always the granular ramifications - just what will this mean for us ordinary folks?

What people fail to emphasize is that Fannie and Freddie bonds are backed by high quality prime assets, according to a senior market observer. For instance, Fannie Mae mortgages have maintained a 1% default rate thus far, he added. These borrowers, who have been on their best behavior, are going to be penalized unnecessarily by Fannie and Freddie going under.

"If you got to the point where you're preventing the GSEs from buying mortgages to put on their books, it's going to slow the market for jumbo loans or for mortgages in higher cost areas," the observer said. "People that need loans larger than the $417,000 limit will be back in jumbo products, where fixed-rate loans have rates of 8% and higher - that's a huge hit to affordability."

At this point, there is no private label market so Fannie and Freddie are picking up the slack. "The MBS market right now is not doing anything that can't be securitized through them - the GSEs put these all on their books," he said.

There's no doubt that, both on a macro and micro level, a potential collapse of Fannie Mae and Freddie could have serious repercussions. But, discussing how they've come to this point is a moot subject.

Right now, both the government and these agencies should simply focus on making Fannie Mae and Freddie Mac viable entities for the good of those innocent and responsible borrowers and for those investors that span the globe.

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

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