Bernanke: Fannie/Freddie Can’t Be Completely Private

Fed chairman Ben Bernanke, speaking at a conference in Berkeley today, reminded people that without government-backed Fannie Mae and Freddie Mac, there wouldn’t be a mortgage securities market, and therefore lenders wouldn’t be able to clear their portfolios to make new loans. Fannie and Freddie have bought about 75% of all mortgages since the credit crisis began. So while there is a strong movement to privatize the companies to rid them of all their government-backed (or previously government-sponsored) faults, Bernanke points out that there would have to be some portion that wouldn’t be privatized so there’s a backstop in times of crisis.

The point is underscored when one plays out what would have happened if we had a private-only mortgage securities market in this current context…the entire system would have melted down. Below are some excerpts of a Bloomberg story on the topic where Bernanke proposes future MBS market options:

Bernanke raised a number of scenarios for the future of the companies, without stating which option he prefers. Securitization, the process where home loans are packaged together into a bond and sold to investors, is important because it allows banks to distribute risk and provides a wider pool of capital to finance mortgages, Bernanke said.

One approach would be to create a government bond insurer which would allow issuers to obtain a government guarantee for their bonds for a fee, the Fed chief said.

“This new agency would offer, for a premium, government- backed insurance for any form of bond financing used to provide funding to mortgage markets,” Bernanke said. Mortgage securities “issued by the privatized GSEs as well as mortgage- backed bonds issued by banks would be eligible.”

The Fed chairman’s comments suggest he believes that a market based on borrowers with anything but high credit ratings would remain fragile and in need of some government support, investors said.

Bernanke also discussed the option of covered bonds, while noting that they might be less competitive with existing finance options. Covered bonds offer banks a way to raise money for new mortgages without either selling the loans or packaging them into securities. Instead, a bank issues bonds that are backed by a dedicated and regularly updated pool of loans, which stay on the bank’s balance sheet.

Another alternative for Fannie Mae and Freddie Mac would be a public-utility model, where the two remain as shareholder- owned corporations and are overseen by public boards, Bernanke said.

“Beyond simply monitoring safety and soundness, the regulator would also establish pricing and other rules consistent with a promised rate of return to shareholders,” he said. The two companies could be folded into the Federal Housing Administration and become full government agencies that securitize mortgages, such as the Government National Mortgage Association, he said.

Washington-based Fannie and McLean, Virginia-based Freddie own or guarantee nearly half the $12 trillion in U.S. residential mortgage debt outstanding. The Treasury agreed last month to inject up to $100 billion apiece in Fannie and Freddie to keep their net worth positive. Freddie’s book value stood at $12.9 billion at the end of June, while Fannie’s stood at $41.2 billion.

Eliminating Freddie’s $18.4 billion in deferred tax credits would leave it with a book value of negative $6 billion and would cut Fannie’s net worth in half, before factoring in other potential writedowns, analysts said.