Last Wednesday's Wall Street Journal editorial, entitled "Fannie Mae Enron?" - which claimed that Fannie Mae and Freddie Mac's risk management techniques, like those of Enron, appear to be "rather frisky" - had no great impact on MBS flows, sources said, and was more of an issue for the Agency market, where spreads widened the morning the piece was published.

Despite the MBS market's dismissal of the article - one MBS analyst called it "histrionic" while another said it may just be a one-day issue - other sources lamented that both agencies have intimidated the Street and that there were actually valid points raised by the article's author.

"Any organization that is able to intimidate analysts after Enron is very, very dangerous and that's why I do not want to be near these securities," said a fixed-income investor. "I think that it is a fascinating story how Fannie and Freddie could get away with this for so long and especially after Enron."

Other MBS experts say that the uncontested power vested in the GSEs would not be a real issue until the head of the Senate Banking Committee, Senator Paul Sarbanes, or the head of the House Financial Services Committee, Representative Michael Oxley, would indicate it is top priority legislation to them to change the rules of how these agencies are run. So far, neither has done so. Oxley, in fact, had indicated earlier this year that the GSE issue is not really on his agenda while Sarbanes has traditionally been known to be pro-GSE.

The effect on the market of attacks like this one on Fannie and Freddie has been smaller as time goes on, especially if compared to how the market reacted when Congressman Richard Baker (R-La) introduced the "Secondary Mortgage Market Enterprises Regulatory Improvement Act" (H.R. 1409) during the spring of 2000, during which time spreads really blew out. This time around, analysts said, the effect is milder.

Specific reference to MBS

The Wall Street Journal article mentioned that Fannie and Freddie have recently been buying back their own securities. Each one, said the Journal, now holds 30% of all MBS outstanding.

Some market participants have expressed discomfort at the fact that Freddie and Fannie are buying up their own bonds.

According to an MBS source, there could be two reasons why the agencies are buying back their own paper.

"It's a good thing if they think the market is not pricing it correctly, if they think that their securities are too cheap and they are buying them back to give them a fair evaluation," he said. However, there may be some downside to this. If the agencies are buying back their own bonds to push the prices up, "then we are talking about manipulation here," said the source.

He further explained that post-Sept. 11, the Securities and Exchange Commission (SEC) changed some of their rules to allow companies to buy X amount of their own shares.

"Now when a company is allowed to buy back some of its own shares according to rules defined by SEC, that's fine, because the commission does provide a limit of how much shares the company could buy back," said the source. "The question is who sets the rules for Fannie when they buy back their own paper. If nobody sets the rules than we are talking about an entity that could get out of control."

Representatives from Freddie said that by buying back their own securities, the agency can support the MBS market and the stronger the market is, the lower mortgage rates are.

"So it's a way we have of not only providing a good investment for Freddie Mac and its portfolio, but of supporting the housing market," said Sharon McHale, a spokeswoman for Freddie Mac. "The more investors out there for MBSs, the more popular they are and the more the price of MBS goes up."

The issue of hedging

The Wall Street Journal article said, "The more we've since looked at Fan and Fred the more they look like poorly run hedge funds: lots of leverage and snarkily hedged risk. The word Enron ring any bells?"

Some people in the mortgage market said that this is a valid point, despite Fannie and Freddie's defense to the contrary.

"On derivative trading, if you look at Fannie Mae's net equity recently, I have been told that it has been swinging up and down," said another investor, "If you are a CFA you know about hedging operation, it is usually meant to stabilize a company's net equity earnings. But the fact that Fannie's net equity earnings has been swinging up and down says that their hedging is not hedging. If there is so much hedging going on, how come their net equity is swinging up and down? Something has to be wrong, either the hedging is wrong or the net equity number is wrong."

Agencies' defense

After the Journal's article was released, Fannie and Freddie did not waste time defending themselves. A press release from Fannie's Chairman Franklin Raines calling the article "egregious" was released the afternoon the article was published. Freddie, on the other hand, posted a response on their sight.

"It is probably the most inaccurate and irresponsible editorial I've ever seen even for the Journal. It's filled with complete errors and hyperbole," said Freddie's McHale.

But some mortgage strategists said that the responses ignore the whole point, which is the fact that it is kind of worrisome when there is so much exposure to entities which really aren't answerable to the government.

"The benefits are spread to the economy in terms of lower housing prices but arguably maybe mortgage credit is too cheap," said a mortgage analyst. "It's great that they definitely help to perpetuate the American dream, but I worry about this whole creeping annexation of the mortgage market to the debt market."

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