New Fannie, Freddie rules on the way

The federal regulator of Fannie Mae and Freddie Mac will set new rules early next week governing the mortgage finance companies' portfolios, which play a crucial role in the nation's housing market.

The Federal Housing Finance Agency is required by Congress to issue regulations ensuring the companies' portfolios are backed by sufficient capital, while keeping in mind their ability to provide funding for the mortgage market by turning home loans into securities. Their portfolios contain mortgages and securities backed by home loans.

The agency will also establish new capital rules for the 12 regional Federal Home Loan Banks, which provide much-needed low-cost funding for more than 8,000 banks nationwide. The home-loan banks have suffered in the economic crisis and may have to reduce their lending to shore up their finances.

"The regulations will address items critical to the safety and soundness of the 14 government-sponsored enterprises, which play a vital role in the nation's mortgage market," said James Lockhart, the agency's director.

Analysts, however, say it's more important to determine the future of Fannie and Freddie, which were taken over by the federal government in September, than to issue portfolio regulations.

"What Congress decides to do with these two companies is the real question," said Jonathan Koppell, associate professor at the Yale School of Management.
Portfolio problems

Fannie and Freddie are the largest sources of funding for the U.S. housing market. They buy mortgages from lenders and either hold them on their books or bundle them into securities. The companies also buy mortgage-backed securities.

Their $1.7 trillion portfolios have long been a source of controversy. Regulators had capped the growth of the companies' portfolios after the pair emerged from accounting scandals earlier this decade in an effort to minimize their riskiness.

But as the mortgage crisis unfolded over the past two years, the federal government has leaned more heavily on Fannie and Freddie to keep the housing market afloat. With investors shying away from buying mortgage-backed securities, the two companies are essentially the only players in the arena nowadays. Regulators lifted the portfolio caps last March.

Fannie and Freddie, however, continue to suffer as delinquencies rise. On Friday, Freddie announced it would ask the U.S. Treasury for up to $35 billion more in assistance as it anticipates losses in its fourth-quarter results. The company has already drawn down $13.8 billion of the $100 billion in federal funds made available to it when it was placed into conservatorship in September.
Trouble at FHLB

Meanwhile, the agency must also set capital requirements at the Federal Home Loan Banks, which are owned by the 8,000 member banks but have an implicit government guarantee. Established during the Great Depression, the home-loan banks are the nation's largest source of residential mortgage and community development credit. They provide low-cost loans, called advances, to member institutions, taking collateral such as high-quality mortgage-backed securities in exchange. Banks nationwide have increasingly relied on the home-loan banks for crucial funding as other sources dry up.

But as the value of the mortgage-backed securities drops, the home-loan banks are facing a credit crunch of their own. Some have cut back their dividends. Others have announced they may fall below their current capital requirements.

If the Federal Housing Finance Agency ups the home-loan banks' capital rules, they may not be able to lend as much. But that may not be a bad thing, experts said.

"The problem of the last five years is that people were doing too much lending," said Thomas Stanton, a lecturer at Johns Hopkins University. "They cannot be as big as everyone would like."