Fannie and Freddie Get a Huge Christmas Gift from Uncle Sam

So much for the U.S. Treasury Department announcing its much-anticipated exit program for government support of Fannie Mae (FNM) and Freddie Mac (FRE). Instead, on Christmas Eve, Treasury said the federal government would provide both with unlimited support for three to five more years. Also, Fannie's and Freddie's CEOs will get pay packages of $5 million to $6 million dollars. Stockholders liked the news and sent shares up by 20%.In no other time would this make any sense. But now, if the government didn't continue its trillion-dollar bailout of Fannie and Freddie, mortgage rates would soar. That would kill the feeble housing recovery and probably result in even more foreclosures. Through Fannie and Freddie, the government has financed 75% of new U.S. mortgages this year. Where would the mortgage market be without that source of funds?%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%

A Higher Cap on Portfolio Size

So far, the government has bailed out Fannie and Freddie with $1.5 trillion in direct and indirect aid. Fannie's and Freddie's Christmas present included the government telling them they could retain their portfolios as long as their holdings didn't top $900 billion. At the end of October, Fannie's was $771.5 billion and Freddie's was $761.8 billion.

Treasury had previously said Fannie and Freddie would need to shrink their portfolios by 10% a year. Now, they won't actually need to trim their portfolios at all for at least another year. And should their portfolios get near that $900 billion cap, don't be surprised if Treasury raises it again -- especially if the housing industry hasn't recovered.

As part of the government support for the two companies, the Federal Reserve has bought $1.1 trillion of Fannie's and Freddie's home loan bonds and $124.1 billion of their corporate debt. The Fed's stepping in where few private investors would be willing to go is aimed at keeping mortgage rates low. The strategy has been working: At year's end, a 30-year fixed rate mortgage was about 5.04% -- down from 6.05%. If the Fed pulls out, mortgage rates would likely jump back up quickly to around 6%.

A Split-Up in the Future?

Despite the big jump in share prices at the news, if you're a Fannie or Freddie stockholder, don't get too excited. The government still holds 80% of the two companies. And now, with decisions about their fate postponed for another three to five years, the stocks aren't likely to see any major improvement any time soon.

Many critics are pushing for both companies to be split up, with the largest segment -- support of government housing policy -- remaining under government control. If and when Fannie and Freddie finally do leave government conservatorship, they're likely to be much smaller, leaner companies.
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