Monday, November 3, 2008

Bernanke - U.S. Must Continue to Back GSE Debt

Federal Reserve Chairman Ben Bernanke said on Friday that U.S. backing for the debt issued by home mortgage finance firms Fannie Mae and Freddie Mac in their current form must stand firm, even though it is appropriate to debate their future.

Uncertainty about how the U.S. government might treat debt issued by the two government-sponsored enterprises (GSE) in the future has depressed investor appetite, keeping U.S. mortgage rates elevated. Speaking to a public policy symposium at the University of California at Berkeley by videoconference, Bernanke appeared to address those concerns.

"Even if alternative organizational structures are considered for the future, the U.S. government's strong and effective guarantee of the obligations issued under the current GSE structure must be maintained," he said.

The U.S. government took over Fannie Mae and Freddie Mac in September as the companies' finances foundered.

Bernanke said that some form of government backing for bundling mortgages together as securities is probably still needed in times of financial strain.

"Experience suggests that, at least under the most stressed conditions, some form of government backstop may be necessary to ensure continued securitization of mortgages," he said.

Fannie and Freddie, which own or guarantee about half the $12 trillion U.S. mortgage market, purchase home loans from mortgage originators and then bundle them into securities that are sold, with a guarantee of payment, to investors worldwide.

Analysts said Bernanke's confirmation of government backing for debt the GSEs have issued and are issuing under government control should help calm mortgage markets.

Bernanke said that if lenders can sell the loans they make into broader markets, a wide array of funding sources is available to them, and they also reduce their exposure to risk. The cost of mortgage lending is lower as a result, he said.

Bernanke said it would be useful to consider the future structures of the companies while they are under government operation.

Letting Fannie Mae and Freddie Mac eventually go back to business under their old charters might encourage the companies again to expand their mortgage portfolios in a risky way to boost profits, he said.

Recent legislation strengthens oversight of the firms but fails to clarify the public purpose of the GSEs' portfolios, he said.

"Systemic risks will remain as long as the portfolios remain large," he said.

Fannie and Freddie were seized by the government as write-downs on their loans held for sale and payouts on guaranteed mortgages that default depleted their capital.

If Fannie Mae and Freddie Mac remain in government hands, Bernanke said the government might create a company to offer mortgage insurance.

"One approach would be to structure a quasi-public corporation without shareholders that would engage in the provision of mortgage insurance generally," he said.

Companies such as Genworth Financial, MGIC Investment and PMI Group offer to insure monthly payments for some borrowers who cannot make a substantial downpayment on a home.

"Private mortgage insurers could still participate in this framework, though the role of the government in supporting mortgage insurance and securitization would be more explicit than it is today."

On the other hand, full privatization of the companies might reduce risks that the companies could destabilize the financial system if they ran into trouble, Bernanke said.

But if the firms were private, there would be no guarantee that mortgages would continue to be bundled into securities during periods of market stress, which could remove an important underpinning for housing markets, he said.

Yet another approach might be to draw the mortgage enterprises even more fully under the government's wing, perhaps by consolidating the GSEs and the Department of Housing and Urban Development's Federal Housing Administration into a "quasi-public corporation without shareholders," Bernanke added.

In summary, Bernanke's speech was geared towards calming the mortgage debt markets and trying to both stabilize and reassure it. If mortgage rates will come down, it will help the housing market, which will filter down to the credit markets, which will benefit the equity markets. At least, Bernanke is out being proactive.

Source: Reuters

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