In for the long haul

Fannie/Freddie: As with many giants, it’s hard to cut Fannie Mae and Freddie Mac down to size. The government, which controls the mortgage behemoths, planned to shrink them by 10 per cent in 2010. Don’t count on it.

Failure is unthinkable, even though both companies still rely on a combined $400 billion equity life-line from the government. These are institutions with a combined portfolio of mortgage-related investments worth a gargantuan $1.5 trillion. Besides, without their supply of financing for home borrowers with good credit, house prices would be a lot lower — and more banks would be in serious trouble.

 

But in theory, Fannie and Freddie could still be allowed to wither away. When they were put into conservatorship in 2008, a special sort of bankruptcy, the plan was to cut back on their hedge-fund like investment portfolios beginning in 2010.

But after March, one other big support of the US housing market will disappear. The Federal Reserve, is supposed to be selling down, or at least not adding to, the $1.25 trillion portfolio built up since January. Private investors are expected to take the Fed’s place. Mortgage-backed bonds still sport triple-A ratings and offer a yield premium over government debt.

But it’s a big hole to fill. And the last thing any politicians want in an election year is for mortgage rates to rise, as they will if private demand falls short. So the government is not going to be in a hurry to let Fannie and Freddie add to the pressure on the weak housing market. They won’t start winding down their portfolios until house prices are much firmer. On the contrary, they will stand ready to act as purchaser of last resort.

Meanwhile the pay packages approved Christmas Eve by the Federal Housing Finance Agency, which oversees the GSEs for the government, and which may reward Fannie head Michael Williams and Freddie CEO Charles Haldeman with up to $6 million, should also keep management doing the government's bidding.

Of course, in the long term the US government should not be in the business of using tax receipts to prop up housing prices and make good on losses from mortgage defaults. That distorts everything about the housing business and adds to the government’s fiscal burden. But barring a government financing crisis, the long term for Fannie and Freddie isn’t going to start in 2010.