Analysis & Opinion : Uncle Sam’s GSE Problem Getting Bigger Not Smaller

By Agnes T. Crane

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The U.S. government wants to wind down Fannie Mae and Freddie Mac. But the task is getting bigger, not smaller. Toxic and hard-to-sell mortgage loans — more than $900 billion of them so far — increasingly dominate the two housing finance giants’ balance sheets.

The numbers from the Federal Housing Finance Agency, which regulates Fannie and Freddie, are astounding. In a 150-page report shipped to Congress last week, the FHFA said 65 percent of Fannie’s $789 billion balance sheet at the end of last year was accounted for by illiquid loans. 


Freddie’s hard-to-trade assets represented more than half of its $697 billion portfolio. The sub-category of distressed assets increased nearly three-fold to $367 billion from a year earlier between the two firms as they bought back severely delinquent loans from the pools underlying mortgage-backed bonds they guarantee.

The regulator expects the proportion of illiquid debt to increase further this year. Barclays Capital estimates the two government-sponsored enterprises are yanking about $10 billion of loans a month out of mortgage-backed bonds. Meanwhile, Fannie and Freddie are required by the terms of their government rescue to reduce the overall size of their balance sheets by 10 percent a year. With toxic and hard-to-sell loans piling up, they have to sell or run off good assets. The trend could continue until the still queasy housing market stabilizes. The GSEs could eventually run out of easily traded assets to sell.

This pattern makes winding down Fannie and Freddie even harder than it otherwise would be. Illiquid investments are difficult to hedge and costly to hold if funding costs rise. And getting rid of their huge holdings — which the two companies will eventually have to do — is sure to be a challenge. Bear in mind the Federal Reserve’s experience with the toxic assets it bought from American International Group AIG.N. The central bank has sold only one-third of the roughly $30 billion of paper it acquired from the insurer, but there are already indications that investors have indigestion.

It’s another reminder that Uncle Sam’s GSE problem is festering. The longer Fannie and Freddie remain sick and their treatment is undecided, the more unpleasant — or, worse, ineffective — the results could be.

- Reuters

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