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A Tale Of Two Fannies
This is a complicated and technical story, but we'll get to the bottom of it.
"Fannie Mae", the Federal National Mortgage Association, is involved in two distinctly different kinds of debt issues. The first, and oldest, is its role as facilitator to the supply of mortgage credit; not as lender, but as guarantor of mortgage-backed securities. Today, there are $971 billion worth of "FNMA MBS" outstanding -- known universally as "Fannies" -- representing more than half the total mortgage credit outstanding in the US.
Fannie is joined in its role as mortgage securitizer by "Freddie Mac", the Federal Home Loan Mortgage Corporation, which like Fannie is a federally-chartered private corporation known in Washington jive as a "GSE", for government-sponsored enterprise. The third securitizer is "Ginnie Mae", the Government National Mortgage Association, but unlike the other two is a part of the federal government.
Fannie has been a great thing for American home ownership, and in its GSE status, together with Freddie Mac, has been granted some special advantages over all other private lenders. Since 1957 the Treasury has backed Fannie with a $2.2 billion line of credit; both GSEs are exempt from state and local taxes; banks are able to make unlimited investments in their securities; and their securities are lawful investments for federal fiduciary and public funds.
The two housing GSEs carry one more powerful advantage: the markets assume that these GSEs are agencies of the federal government which would be bailed out if they ever got into trouble. This never-fail status confers two further advantages: Fannie borrows at interest rates almost a half-percent lower than non-GSE corporations with comparable credit, and on vastly higher leverage, $32 in debt per unit of capital versus the 12:1 ratio common for a large bank.
Fannie and Freddie operate in similar fashion in mortgage securitization; however, Fannie has guaranteed four times as many MBS as Freddie, and operates as an investor as well, holding a half-trillion dollars in mortgage investments including $281 billion of its own MBS.
Fannie's second form of debt involvement has been its own need to borrow to finance these mortgage investments. The bonds and notes which Fannie sells to raise money are completely separate and different from Fannie MBS. These bonds and notes are "straight debt", paying fixed rates of interest to a known maturity date -- unlike MBS with their very peculiar sensitivity to mortgage prepayment.
Enter opportunity, hubris, and trouble.
As of this spring, the Treasury is using the federal budget surplus to buy back its long term bonds -- the ones which the credit markets had used as the benchmark for setting interest rates on all other debt issues, federal, corporate, and municipal. The markets are trying to identify another benchmark bond, one with solid credit and a large enough volume outstanding to supply market liquidity.
Already a big issuer of bonds, Fannie decided that it was perfectly positioned to replace the Treasury as the benchmark issuer. To do so, Fannie would borrow in vast quantity (Fannie will issue $120 billion in new bonds this year in addition to the $550 billion already outstanding); however, to borrow in such quantity would depart from Fannie's housing mission.
Last month, the Treasury had a fit over Fannie's plans, and proposed legislation to remove all the advantages to housing GSEs. The threat has hurt Fannie debt, though not yet the mortgage market.
The Treasury's argument has some merit: if Fannie has no open market discipline, expands is charter willy-nilly, and gets in trouble with enormous sums borrowed, the Treasury will get the call for a bailout. The Treasury has been joined in this assault by the traditionally envious crew of bankers who do not have Fannie's GSE advantages, and by normally housing-friendly Republicans in the nitwit fringe who object to all government involvement in anything, no matter how beneficial and safe.
And beneficial and safe Fannie has been. Fannie is a secured investor -- home loans backed by American homes -- not an unsecured operation like the student loan program, nor partly-secured small business loans, nor farm loan programs secured by wishful thinking. Nobody has ever lost a dime on the credit of a Fannie MBS... on interest rate movements, certainly; but never credit.
There is more to Fannie's benchmark desire than ego: if its direct debt became a benchmark, it could be floated at lower interest rates, and Fannie could pass the savings on to homeowners. And, floundering markets could certainly use a new long-term benchmark.
Historically, Fannie has been expert at defending itself from political attack, and I'll bet damage from this Treasury assault is limited -- probably no worse than a Fannie agreement to slow its borrowing. A modest spanking, all in all.
One task remains to prepare for a Fannie-on-the-benchmark future.
Wall Street is deeply fond of nicknames for its benchmarks: strips, clips, junk, gilts, yankees, and so on. If Fannie is going to replace the fast-disappearing Treasury "long bond" with its own benchmark 30-year issue, the Fannie issue must have a nickname. Benchmarks aren't taken seriously at trading desks without a descriptive, can't-be-confused nickname, definitive when shouted under terrible pressure across a noisy trading floor.
There is really only one choice, of course... the long Fannie bond will be known as... the thong bond.
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