Fannie Mae, Freddie Mac Turmoil Pose New Economic `Headwind'

By Matthew Benjamin and Craig Torres

July 12 (Bloomberg) -- The slides in Fannie Mae and Freddie Mac, the largest providers of U.S. mortgage financing, threaten to deepen the economic slowdown by curbing credit to a housing industry already in its worst recession in 25 years.

The two companies' shares reached the lowest level in more than 17 years yesterday, making it tougher for them to raise capital at a time when they account for about 80 percent of mortgages packaged into bonds. A failure of the companies would likely send home loan rates higher, causing further declines in home sales and prices.

The dangers mean the Bush administration, which yesterday indicated a government takeover isn't needed, must be ready to keep the companies afloat, investors said. Lawmakers aim to take up a housing bill next week to help buttress confidence in Fannie Mae and Freddie Mac.

``There is no way the [=^]federal[^=] government is going to let either of those agencies die,'' said Eric Hovde, chief executive officer of Hovde Capital Advisors LLC, which runs a $1 billion hedge fund. ``You can't take housing, which is the most important asset class in the country, and mortgages, which are the largest debt markets, and destroy them.''

Fannie Mae and Freddie Mac own or guarantee about half the $12 trillion in U.S. home loans outstanding. Even if the government steps in with some type of rescue, mortgage rates may rise as much as half a percentage point as the cost of selling mortgage-backed securities rises, said Keith Gumbinger, vice president of mortgage research firm HSH Associates in Pompton Plains, New Jersey.

`Headwind for the Economy'

``No matter how this turns out, you have to think'' the mortgage market ``is going to be under more strain,'' said Brian Sack, a senior economist at Macroeconomic Advisers LLC in Washington who used to work at the Federal Reserve. ``That is a headwind for the economy, and something the Fed will have to take into account'' in considering when to raise interest rates.

Fed Chairman Ben S. Bernanke will deliver updated quarterly forecasts when he gives his semiannual testimony on the economy to Congress next week. Traders anticipate the central bank will raise rates this year to head off an acceleration in inflation spurred by oil and food costs.

The Fed, which opened lending to investment banks in March in the first extension of credit to nonbanks since the 1930s, is looking at options for Fannie Mae and Freddie Mac along with other agencies.

`Range of Options'

Spokeswoman Michelle Smith said in an interview she was ``not prepared to discuss the range of options and alternatives being considered.'' The Fed hasn't spoken with the two firms about access to direct loans, she said.

Treasury Secretary Henry Paulson said in a statement yesterday that ``our primary focus is supporting Fannie Mae and Freddie Mac in their current form.'' The government-sponsored enterprises have [=^]federal[^=] charters and are shareholder-owned companies.

Shares of the two companies closed lower, with Fannie Mae losing $2.95 to $10.25 and Freddie Mac down $0.25 at $7.75 in New York Stock Exchange composite trading. Washington-based Fannie Mae's market capitalization has fallen to $10.1 billion from $38.9 billion in December, according to Bloomberg data. McLean, Virginia-based Freddie Mac's total has slumped to $5 billion, from $22 billion over the same period.

``The substantially smaller market values could dramatically hinder the companies' ability to raise additional capital,'' CreditSights Inc. analysts Richard Hofmann and Adam Steer wrote in a note to investors Friday.

House Prices Fall

The declining availability of credit pushed down home values in 20 U.S. metropolitan areas during April at a record rate, according to the S&P/Case Schiller home-price index. The index dropped 15.3 percent from a year earlier.

Senate lawmakers yesterday approved a bill including $300 billion to help thousands of Americans keep their homes and tighter regulation of Fannie Mae and Freddie Mac. The House previously approved its own version, and legislators may reach agreement on a final bill to send to President George W. Bush for signature next week, Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said yesterday.

Economists already anticipate economic growth will dwindle to a 0.6 percent pace by the final three months of 2008, the weakest pace in six years, according to the median estimate in a monthly Bloomberg News survey. Declines in residential construction have subtracted from gross domestic product for nine straight quarters through March.

Rising Role

As mortgage providers retreated from signing new loans, the housing market has relied on Fannie Mae and Freddie Mac to step up. The two firms accounted for 81 percent of the home loans that were packaged into securities in the first quarter, according to the Office of [=^]Federal[^=] Housing Enterprise Oversight.

``This rapid growth pace'' in firm's portfolios ``will probably need to continue if we want to avoid an even sharper deterioration in overall credit availability than is already occurring,'' said Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York. Deteriorating credit creation is the ``key vulnerability'' for the U.S. economy, he said.

To contact the reporters on this story: Matthew Benjamin at mbenjamin2@bloomberg.net

Last Updated: July 12, 2008 00:01 EDT

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