The vagueness of the phrase “implied guarantee” hit markets hard in the 2008 financial crisis, when investors wised up to the fact that Fannie Mae and Freddie Mac’s governmental backing and status as government sponsored enterprises was untested and undefined. In the years since, most of the major investors in GSE debt are steadily moving out of the Fannie and Freddie market and into bonds backed by the “full faith and credit” of the U.S. government, namely Ginnie Mae bonds and Treasuries.
This trend of large-scale buyers exiting the market isn’t tipped to stop any time soon. “What we’ve seen is a sharp switch in foreign central banks’ portfolios,” Mark Hanson, v.p. of mortgage funding at Freddie Mac, told SI. “For many years foreign central banks were among the largest investors in agency mortgage-backed securities. Now the Ginnie-Conventional swaps indicate a migration from implied guarantee bonds to those backed by the full faith and credit of the U.S. government.”
Foreign buyers are no longer willing to make do with an implied guarantee, he added. “What foreign central banks want is a resolution of the guarantee,” Hanson said. “Until we arrive at some kind of resolution on the guarantee, they’re reluctant buyers of agency MBS.”
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Ted Tozer
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Ted Tozer, president of Ginnie Mae, agreed 2011 saw more foreign and central banks move into Ginnie bonds, and added he sees an uptick in Ginnie buying activity from players inside the U.S. as well. “When I talk to the market-makers, they’re telling me they see domestic and commercial banks growing their positions in Ginnie Mae,” Tozer noted. He said he thought it was partially due to the need for banks to comply with new risk weighted capital requirements, which would require them to hold capital against Fannie and Freddie bonds, but not against Ginnies, because of Ginnie’s explicit guarantee.
Tozer said he doesn’t have high hopes for movement on resolving the limbo status Freddie and Fannie have been in since 2008, when the agencies were placed in conservatorship. “I think the best we can hope for in 2012 as far as resolution of the guarantee is discussion,” Tozer said. “Hopefully substantive discussion. Because it’s an election year, the political reality is that you probably will not get a consensus.” He said that he hoped 2012 saw more information gathering and possibly more hearings on the topic in Congress, and that he hoped legislators would at least move toward formulating new policy on resolving the issue of conservatorship and the implied guarantee of Freddie and Fannie RMBS.
But it doesn’t seem like any sector of the market, from foreign buyers to U.S. dealers to governmental regulators, is holding its breath for a resolution of the guarantee to come any time soon. Campaigning politicians from both sides of the aisle called for a swift end to Fannie Mae and Freddie Mac in both the 2010 and now the 2012 elections, but so far credible proposals for resolving the guarantee and enticing foreign buyers back into the market remain scarce. Meanwhile, Fannie and Freddie originate as much as 95% of U.S. residential mortgages.
After Freddie and Fannie went into conservatorship, the Federal Reserve Bank of New York began a program to prop up the flailing agency MBS market. The New York Fed bought $1.25 trillion in agency MBS from Jan. 2009 to March 2010. The size of its buying program indicated to the market that it was a large volume program with a short duration, a market official speaking with SI said, intended only as an emergency measure to help the market get back on its feet after the burst of the subprime bubble.
But in September 2011, Federal Reserve Chairman Ben Bernanke made a surprise announcement: the Fed would reinvest paydowns on its portfolio of both agency and private label RMBS into agency RMBS. The decision meant that instead of gradually exiting the mortgage bond sector, as the market had anticipated, the Fed would use the funds generated by the bonds it held hitting maturity or prepaying to buy more agency RMBS, meaning the Fed was staying put in mortgages and putting a renewed focus on the agency sector. Now participants speculate there could even be a third round of Quantitative Easing from the Fed that would include agency mortgage buys, the official speaking with SI said.
As the agencies continue to have their strongest bid come from government buying programs, Tozer said Ginnie Mae is creating new programs to improve its product and work with its influx of investors. One new program for the market to watch for in 2012 will be an issuer performance scorecard. In Ginnie terms, an “issuer” would be what is more commonly called a “servicer” in the rest of the mortgage world. The scorecard would measure prepayment speeds among the different issuers. Ginnie would then share the scorecard among the issuers, so that they could see if one issuer’s prepayment rate was significantly higher than another’s. This compilation of information would act as a tool to normalize prepayment rates among the Ginnie issuers, Tozer explained. He said the scorecard program was designed to reassure Ginnie investors, and that eventually it would also be made public to them.