For more than a decade, Fannie Mae and Freddie Mac, the housing giants that make the US mortgage market run, have attracted overseas investors with a simple pitch: The securities they issue are just as good as the US government’s, and they usually pay better.
The marketing plan worked. About one-fifth of securities issued by Fannie Mae, Freddie Mac and a handful of much smaller quasi-governmental agencies, amounting to some US$1.5 trillion, were held by foreign investors at the end of March. One out of 10 mortgages in the US is, in effect, in the hands of institutions and governments outside the US.
Now that the two companies are at risk, how their rescue is handled will ultimately test the world’s faith in US markets. It could also influence the level of interest rates and weigh on the strength of the dollar for years to come, analysts say.
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“No less than the international perception of the credit quality of the US government is at stake,” said Richard Hofmann, an analyst with CreditSights, an independent research house with offices in London and New York.
Also at stake is the ability of Americans to gain access to credit. If foreign companies and governments abandon US investments, then home, auto and credit card loans will be much more difficult to obtain.
That helps explain why Treasury Secretary Henry Paulson is pressing US lawmakers for the authority to inject unspecified billions of dollars in cash into either Fannie Mae or Freddie Mac, or both. The “blank check” nature of his request has raised concerns on Capitol Hill, but Paulson is betting that Congress is even more fearful of the consequences of doing nothing to rescue Fannie Mae and Freddie Mac.
On Sunday, in an appearance on the television program Face the Nation, Paulson said he was “very optimistic that we’re going to get what we need from Congress.”
“Congress understands how important these institutions are,” Paulson said.
Asian institutions and investors hold about US$800 billion in securities issued by Fannie Mae and Freddie Mac, the bulk of that in China and Japan. China held US$376 billion and Japan US$228 billion as of June last year, the most recent country-specific Treasury figures.
In Europe, roughly US$39 billion in Fannie and Freddie debt is held in Luxembourg and US$33 billion more in Belgium, countries that are home to large investment management firms. Investors in Britain hold US$28 billion, and Russian buyers hold US$75 billion. Sovereign wealth funds in the Middle East are also believed to be big investors in Fannie and Freddie debt.
The trillions of dollars in securities issued by Fannie Mae and Freddie Mac and backed by US mortgages were never explicitly guaranteed by the US government, but foreign and domestic investors alike have always believed — because of the companies’ integral role in the housing market and their marketing pitch — that the guarantee would be backed up if it were tested.
As the US government’s debt, and the corresponding amount of Treasury securities, shrank in the late 1990s, foreign investors with currency reserves needed a safe alternative to park their cash. Fannie Mae and Freddie Mac stepped up their overseas marketing efforts and, with the help of Wall Street banks, sold billions of dollars in securities overseas.
Asian banks and insurers bought Fannie’s and Freddie’s paper because it gave a little more yield than a straight Treasury note — “the same risk at a better price,” said Deborah Schuler, an analyst with Moody’s Investors Service in Singapore.
Investment managers at Asian banks and central governments are “very comfortable with the idea of implied government support” because it is so prevalent in Asia, Schuler said.
Still, this week’s congressional debate on the issue “is going to worry people,” Schuler said, though she, like most analysts, is confident that Washington will deliver, just as it has in past financial crises, like the savings and loan industry bailout of the late 1980s and early 1990s.
Because the US’ relations with a host of countries are intricately tied to Fannie Mae and Freddie Mac, the only realistic option open to lawmakers may be to hand the Treasury Department that blank check, analysts say.
The two housing agencies have always been fierce competitors, and they made no exception in their expansion into international markets. Top executives wooed governments, banks and insurance companies in Asia and Europe, and lent executives to help foreign governments, including Russia and Hong Kong, set up their own US-style mortgage markets.
Both companies often compared their product to US Treasuries when they talked to international investors, and adjusted the way that bonds matured and were priced so they looked and acted more like Treasury bonds.
In an interview with a London financial trade paper in 1999, Jerome Lienhard, Freddie Mac’s senior vice president of investment funding, said: “Investors that make the transition from US Treasuries to our securities will be pleased with the performance.”
Freddie Mac’s program is “designed to mirror that already used by the United States government,” he said.
The Treasury will not comment on Fannie and Freddie’s international marketing pitches, but in the past it has tried to rein in the two institutions.
In March 2000, Gary Gensler, then Treasury undersecretary, proposed more oversight of Fannie Mae and Freddie Mac, testifying to Congress that the two agencies “receive no funds from the federal government, and the government does not guarantee their securities.”
The firms “have been promoting their debt securities as an alternative market benchmark” to Treasuries, he noted, particularly as the amount of Treasuries issued by the government shrank with the deficit. Gensler’s comments roiled mortgage markets, sending prices down sharply on traded Fannie and Freddie-backed securities and on both companies’ stock. Ultimately, the controls he proposed were softened.
The bulk of investments related to Fannie Mae and Freddie Mac are in the form of mortgage-backed securities, often called “agency securities” or “agency paper.” This agency paper is considered of much higher quality than securities backed by subprime loans because Fannie Mae and Freddie Mac generally lend to borrowers with good credit histories and require higher down payments.
Prices on senior Fannie Mae and Freddie Mac securities, the highest quality, have not changed significantly since the end of last year, even as the two companies’ stock prices have plummeted, Moody’s noted. As of June 30 this year, prices on a typical Fannie or Freddie security maturing in 10 years were off only about 2 percent from last December.
Questions about Fannie Mae and Freddie Mac have prompted individual institutions and governments in Asia and Europe to specify their exposure in recent days, but so far international concern has been limited.
Ingo Buse, a spokesman for Zurich Financial Services, Switzerland’s largest insurer, said it held US$8.3 billion in mortgage securities backed by Freddie Mac or Fannie Mae, and felt “comfortable with our position and asset allocation.”
Swiss Reinsurance, Switzerland’s largest reinsurer, said on Wednesday last week that it held US$9.6 billion in corporate debt from Freddie Mac and Fannie Mae and US$12 billion in mortgage securities backed by the two companies. Swiss Re’s holding of Freddie Mac and Fannie Mae shares is minimal, it said.
Hannover Re, Germany’s second-largest reinsurer after Munich Re, said it held 125 million euros (US$199 million) in securities issued by Freddie Mac and Fannie Mae.
“We are not worried about the exposure,” said Stefan Schulz, a spokesman for the company, “because we expect the US government to step in if there is any problem.”
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