Fannie Mae and Freddie Mac had record levels of profits, mortgage purchases, and mortgage-backed security production in the first quarter and near-record levels in buybacks of MBS coupons.
That sounds great, but experts say it may be too much of a good thing.
Freddie Mac issued $85.50 billion of pass-through certificates through the first third of the year and repurchased 48.9% of that volume for its own portfolio, according to the newsletter Inside MBS & ABS. Fannie Mae reported $127.69 billion in new MBS production, which is originated by lenders but guaranteed by Fannie; it purchased $51.34 billion, or 40.2% of that $128 billion.
As a result of its first-quarter purchases, Freddie now owns more than 31% of its pass-through certificates outstanding, while Fannie owns more than 34% of its outstanding mortgage-backeds. Those numbers from the newsletter were confirmed by both Fannie and Freddie.
Executives with the government-sponsored enterprises said the purchases drove much of their first-quarter earnings and are a powerful tool through which they can lower mortgage rates for consumers. Further, these executives said, the purchases channel money from global capital markets through the debt that Fannie and Freddie issue to make the purchases.
But some in the industry worry about the impact of this practice on the secondary mortgage market. Heavy MBS purchases may make Fannie and Freddie vulnerable to interest rate risk, these people say.
Peter Wallison, a resident fellow at the American Enterprise Institute, explained that when the GSEs issue mortgage-backed securities, they assume the credit risk involved with the underlying mortgages. When the GSEs buy their mortgage-backed securities, they also assume the interest rate risks.
Should interest rates rise sharply, Fannie and Freddie could lose money, because they could end up paying higher rates for the debt they borrow in comparison to the money coming in from the mortgage-backeds that they own, Mr. Wallison said. He also questioned the GSE risk managers' ability to anticipate interest rate catastrophes.
"It depends on what they think the future of interest rates is," he said. "Nobody knows which way interest rates will go."
Michael House, executive director of FM Watch, a staunch critic of Fannie and Freddie, suggested that this practice may be outside their government charter. "If no action is taken on these two entities, they may become nothing more than a government-sponsored Ponzi scheme," he said.
Others say the GSEs' large holdings of mortgage-backed securities could hurt market liquidity.
Executives from Fannie and Freddie took issue with these criticisms and said the purchases help keep mortgage prices in check for consumers.
Freddie's mortgage bond purchase volumes "are essentially driven" by the levels of spread in the mortgage market, said Joseph E. Amato, its vice president of finance. As spreads widen, he said, Freddie's portfolio goes into the marketplace and predominantly buys pass-through certificates, which brings spreads down overall.
The purchases are financed by debt issued to the global capital markets, which generally do not invest heavily in American mortgage debt, Mr. Amato said. "Our retained portfolio effectively provides an avenue by which global capital can be channeled into the mortgage finance system."
Mr. Amato also argued that such heavy mortgage bond purchases helped stabilize the mortgage market during the capital crisis of 1998. "There was no disruption of funds to the U.S. housing market, because Freddie Mac's retained portfolios were actively buying loans and MBS and holding them, making the market stable," he said.
Jayne Shontell, Fannie Mae's senior vice president of corporate development and investor relations, explained that her company bought heavily into mortgage bonds after investors fled the market as a result of the consumer refinance boom.
"As mortgage prepayments picked up, a lot of investors didn't want to hold mortgage-backed securities," she said. "They didn't want to deal with those prepayments." Fannie, picking up the role of investor, helped keep the MBS price high and the yield low, she said. "Otherwise, mortgage rates would have gone higher."
Ms. Shontell said Fannie's heavy MBS holdings foster market liquidity.
"Liquidity, typically on anything, tends to be measured by the difference between the price at which someone will buy it and the price at which someone will sell it," she said. "If you were to call any Wall Street firm and ask them what the bid spread has been, they'd tell you it was really tight, probably as tight as any market out there. That is a liquid market."
Ms. Shontell also maintained that the purchases do not stray outside the GSEs' mandate. "If you look at our charter, this is exactly what we are supposed to be doing," she said. "We are supposed to provide stability for residential mortgages. We are supposed to respond appropriately to the markets."
