March 19, 2008: The government today reduced the capital reserve requirements for Fannie Mae and Freddie Mac, giants in the secondary mortgage market. These companies were required to maintain a 30 percent capital reserve; and this was today reduced to 20 percent. The government regulator of Fannie and Freddie will consider further reductions in the future if needed.
This reduced cash reserve requirement will allow Fannie and Freddie to raise about $200 billion. The companies expect to raise billions of dollars through special sales of stock. Stocks of both companies rose significantly after today’s announcement.
This move is aimed at making greater housing finance available for new homebuyers and for existing homeowners who may want to refinance into more affordable mortgages. There is a significant shift in the government’s stance on the role of these government sponsored enterprises, Fannie Mae and Freddie Mac. The government seems to be viewing them more and more as a buyer of the last resort for primary mortgages and mortgage-based securities at a time when these markets are troubled.
Currently, Fannie Mae and Freddie Mac together hold nearly $20 billion in cash reserves. (Although in recent times, they had held reserves worth $53 billion). According to the regulator of these companies, the Office of Federal Housing Enterprise Oversight (OFHEO), cash reserves of these companies will come down by a third as a result of the new rules.
The government has recently made other changes with respect to Fannie and Freddie in order to ease the home mortgage finance crisis. As a part of the stimulus package enacted last month, the government raised the upper limit of the mortgages that these companies can buy or guarantee from $417,000 to $729,750 in high-cost markets. The mortgage limits were raised in several market areas across the nation. Then, on March 1, 2008, the government removed the combined cap of $1.5 trillion on the mortgage-investment holdings of these two companies. Thus, this plan today (Wednesday, March 19, 2008) is the third action that the government has taken in recent times with respect to Fannie and Freddie, aimed at injecting greater liquidity into the housing finance system and creating confidence in home mortgage markets.
OFHEO estimates that these actions will allow Fannie and Freddie to purchase or guarantee roughly $2 trillion in mortgages this year. Currently, the two companies taken together hold or guarantee around $4.9 trillion in home-loan debt.
Reactions to today’s move have been mixed. Republican lawmakers have for long been opposed to allowing Fannie and Freddie to take on more debt unless the regulator for these companies is strengthened significantly. They believe that more debt and allowing these giants to grow further will harm the global financial system. Prominent Republicans like Senator Richard Shelby have opposed this move and believe that a stronger regulator is needed for Fannie and Freddie. According to him, this move exposes the taxpayer to enormous potential risks.
Prominent Democrats such as Senator Chuck Shumer and Senator Christopher Dodd have welcomed this move. Chuck Shumer called it “a real shot in the arm to the idea that maybe we can get a good handle on the foreclosure crisis.”
The call for a stronger regulator for Fannie and Freddie makes sense in light of the recent accounting scandals in both companies. In the immediate term, this lowering of capital reserve requirements could be beneficial. However, regulators should raise the capital reserve requirements back to the old level after housing markets have stabilized.
However, the lack of transparency in the operations of these mortgage giants in terms of what the American public knows about them is quite troubling. It seems that deals are being struck behind closed doors between regulators and huge companies of which the American people have little prior knowledge. These deals don’t seem to be in response to public opinion. OFHEO ought to be required to seek public comment and opinion before it changes the rules.