The Problem with the GSE Nationalization

By Alan White

Once again the Treasury Department has stepped in to protect investors in mortgage-backed securities (this time those of Fannie Mae and Freddie Mac) but has not addressed the underlying problem. Now that the US taxpayer will become both a creditor and shareholder of the GSE's, it becomes all the more urgent for the government to address the foreclosure crisis itself.

Fannie and Freddie have seen their capital base erode as a direct result of the losses on subprime and Alt-A mortgages, losses which continue to mount and could be reduced considerably with appropriate intervention. The GSE's fates are tied to subprime and Alt-A loans in at least two ways. First, they were among the biggest purchasers of subprime mortgage-backed securities. While CDOs and hedge funds bought the riskiest tranches of the horribly underwritten subprime and alt-A loans of 2006 and 2007, the GSE's were snapping up the senior tranches. As a result, the capital of the GSE's, the thin slice that is supposed to support their debt obligations if their assets lose value, depends on the performance of subprime mortgages. Freddie Mac in particular has been overstating its capital by not marking down its (formerly) triple-A subprime securities, on the weak premise that by holding the securities to maturity it would recover 100% of their value. Rating agencies are predicting losses as high as 25% on 06/07 subprime loans, which implies big losses in senior subprime securities.

The second link between subprime foreclosures and the GSE's continued viability (or the extent of taxpayer money needed to prop them up) is the impact of subprime and alt-A foreclosures on the continuing decline of home values. Until the steady increase of monthly foreclosure filings is stopped, foreclosed homes will continue being added to the REO inventory, putting additional downward pressure on markets that are already dominated by vacant, lender-owned homes.

Now that the investors, for whom mortgage servicers are ostensibly working, are US, we should insist on a halt to new foreclosure sales until a systematic and effective mortgage restructuring program is put in place and implemented.

P.S. - in most other countries, when the government replaces the management and acquires the right to own 80% of the stock of a company, it is called nationalization. In the U.S. we don't like to use that word.