Rafferty Capital Markets’ Richard X. Bove continues his commentary regarding the Fannie Mae saga, taking issue with a recent Wall Street Journal article.

Once Again We Disagree With the WSJ

In Monday’s edition of the Wall Street Journal the following claims are made:

  • The profits that being reported by the Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are due to the government subsidizing their borrowing costs.
  • If these companies were systemically important banks they would require substantially more capital.
  • Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) may still owe the government $116.8 billion in bailout money.

Bailout Money

Let’s start with the last point first and work our way up the list. The table below provides the numbers related to the bailout.

Fannie Mae Freddie Mac Bailout FNMA FMCC

Fannie Mae Freddie Mac Bailout

  1. The amount the Treasury invested in Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) in millions.
  2. The amount repaid to the Treasury by these companies.
  3. The cash profit on the investment.
  4. Unrealized security values.
  5. The current value of the senior preferreds.
  6. The current value of the warrants owned by the Treasury at market.
  7. Total unrealized security values.
  8. Total profit on the bailout investment.
  9. Potential additional profit if Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are returned to the investment public.

Not shown in the table is that the government can collect $22.5 billion a year in dividends on this investment, forever, if it does not request a repayment of the outstanding senior preferreds.

These are the easily calculated monetary benefits that the taxpayer has received through its rescue of Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). However, the real benefits are well beyond this amount:

Mortgage Savings

There are $9.8 trillion dollars in residential mortgages outstanding. The interest rate on these loans is below market because the funding advantage that the GSEs obtain is passed along to the homeowner in the form of lower mortgage rates. Assume a 10 basis point savings and the cost reduction to taxpayers who own homes is $9.8 billion per year; no Fannie Mae and Freddie Mac,no savings.

The Wall Street Journal believes that the interest rate subsidy Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) receive is 280 basis points. If one assumed that this is what is passed along to consumers the savings they get on their mortgages is $274 billion.

Housing Prices

Setting aside interest rate subsidies for the moment, if there were no GSEs there would be no 20 and 30 year fixed rate mortgages. If you question this statement call any 10 banks you would like and ask if they would make such loans without the ability to sell them to Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). If you get the answers I do you will find out fairly quickly that they will not.

So let’s play with numbers. The median price of a single family home sold in the existing home market is $195,000. The median household income is $51,017. If that household were to buy the median priced home today; put down 20%; and pay the current Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) mortgage rate of 4.43%, on a 30-year fixed rate loan, the monthly cost of that home would be 18.4% of the household’s gross income. Assume that this same household bought the house with a 10-year adjustable rate mortgage at the average mortgage rate of the past 20 years. This household would be paying 41.3% of gross income and would not be able to obtain a qualified mortgage.

Housing Prices

Now let’s flip the numbers. Let’s assume that the household in question is willing to pay up to 40% of its gross income to buy a house. Using the fixed rate mortgage and the current mortgage rate, plus assuming a 20% down payment, the maximum price affordable would be $425,000. Using a 10 year adjustable rate mortgage at the average mortgage rate of the past 20 years the maximum price that can be paid is $190,000.

Mortgage rates

I will let you the reader play with the numbers but I think that the point is clear. The taxpayer saved himself a very sizable amount of money by keeping Fannie and Freddie around. One can make a compelling case that the economy also benefitted meaningfully by keeping Fannie and Freddie alive and this also aided the taxpayer significantly.
The numbers are very clear. The taxpayer did not bail out Fannie and Freddie; s/he bailed out him/herself. By doing so the taxpayer also pocketed hundreds of billions in profit; saved the value of his/her home; and prevented a greater route in the housing market. It was a win by any measure except the ones used by the Wall Street Journal.

Fannie Mae and Freddie Mac Require More Capital

Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are not banks. They are not being regulated by any of the banking authorities. They do not have access to the Federal Reserve discount window. Making the assumption that they are systemically important and placing them under Basel III regulations has more impact than simply requiring Fannie and Freddie to obtain more capital. It also implies that any sizable financial company must be placed under Basel III. Of course, demanding that these companies be better capitalized creates more math the end result of which is lower housing prices and a weaker economy.

What Do We Want?

This leads back to the first point. Do we want Federal agencies that help subsidize mortgage costs or not? If not then Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) should be eliminated. If we do then these companies should be nurtured returned to the public and allowed to grow. They cannot grow under the conditions established by the Treasury. They will go away and all of the benefits to the housing market and economy will go with them. This is what the Wall Street Journal wants. Is it what the American public really wants?

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