Sun, October 26, 2008
Fannie and Freddie’s Debts Are Not Explicitly Guaranteed
Last month I wrote that the federal government, in its takeover of Fannie Mae and Freddie Mac, had begun effectively guaranteeing the debt of the two agencies. But it became clear this week that the government is still hedging about the extent of its backing of the agencies' debts.
James Lockhart III, director of the Federal Housing Finance Agency, which is responsible for handling the conservatorship of the two mortgage agencies, gave written testimony to the Senate Banking, Housing and Urban Affairs Committee indicating that the government is providing “an explicit guarantee to existing and future debt holders.” However, when Lockhart addressed the committee, he modified his marks to “an effective guarantee,” and a later statement from one of his subordinates indicated that this effective guarantee is limited to $100 billion of preferred equity that may be injected into the two agencies.
The government clearly wants to encourage the idea that the debt of Fannie and Freddie is low-risk in order to allow the two companies to borrow money at low interest rates, but despite the initial slip, there is no firm guarantee. The debt of the two agencies should not be thought of as having the same safety as Treasury obligations.
In fact, as the Wall Street Journal notes, the wording of the government’s effective guarantee indicates that the government will not permit the agencies to become insolvent. But since regulators are now free to suspend the requirement for the agencies to mark their impair assets at their market values, the agencies could have negative net worth, yet not be insolvent under generally accepted accounting principles.
With the FHFA head backing away from more explicit language, it seems wise to view FNMA and FHLMC debt as less risky than it was before the conservatorship, but as still several notches risker than Treasuries.