Major Changes Ordered at Freddie Mac and Fannie Mae

By Mike Colpitts

Responding to outcries over Wall Street and its actions with troubled Fannie Mae and Freddie Mac, new proposed federal regulations prohibit the two government-backed lenders from purchasing mortgages of private-label securities in the future, including commercial mortgage-backed securities, a major cause of the financial crisis.

The regulations, proposed by the Federal Housing Finance Agency launched by the Obama administration, halt the purchases and are seen as an effort to improve mortgage lending conditions. Investors looking to increase income purchased private-label, mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) to reap higher profits on Wall Street.

Wall Street Bear and Bull

Pools of mortgage securities provided the cash to fuel the real estate boom, and the subsequent foreclosure crisis and financial crisis. Mortgage securities were “securitized” by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Investors loved the investment pools for their high returns and low risk because the agency accepted the credit risk on the underlying loans and guaranteed the payment in case a mortgage failed until the financial crisis struck.

The regulations ordered by the FHFA intend to limit risk taking by Fannie Mae, Freddie Mac and the 12 federal home loan banks it oversees. Fannie and Freddie now purchase an estimated 95% of all home mortgages sold nationally. The actions mark a major change in the way the lenders will be allowed to conduct business even before Congress takes up the challenge of how to go about repairing the two largest U.S. mortgage lenders, which have been bailed out by tax payers purchasing $148-billion in troubled mortgage-backed securities.

Treasury Secretary Tim Geithner is due to report to Congress early next year with his recommendations on how the two major mortgage lenders should be repaired. But it is expected to take members of both legislatures years to wrangle with the problems that exist at Fannie Mae and Freddie Mac before solutions can be agreed to in Congress.

Loose lending regulations, promoted as part of the Bush administration’s efforts to expand home mortgage lending to all levels of society led to the highest amount of mortgage lending both in sub-prime mortgages and conventional mortgages in U.S. history during the real estate boom. The lending explosion provided the dollars to back the securities that provided the cash to fuel the real estate buying mania with little oversight by federal regulators.

“The new goals also reflect essential conservatorship requirements to ensure the Enterprises (Fannie and Freddie) focus on core business activities to support the mortgage market while minimizing losses on their existing mortgages,” the FHFA said in a statement.

The proposed changes were announced by the agency as part of its development to charter the future course of the nation’s largest mortgage lenders, and are an attempt by the government to restore faith in the U.S. mortgage system destroyed by the foreclosure crisis. The proposal becomes law 30 days after it is entered into the federal registrar, which will be Oct. 2nd.

As part of its re-design of the system, the Federal Housing Finance Agency is also establishing new housing goals for Fannie and Freddie in 2010 and 2011. The Housing and Economic Recovery Act implemented in 2008 required the agency to establish new goals for the two lenders as directed by Congress. The Department of Housing and Urban Development (HUD) set goals that measured the performance of single-family and multifamily mortgages in previous years.

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