Tuesday, March 22, 2005

Shrinking Mortgage Machine

Shrinking Mortgage Machine
by Charles Mackay, Tuesday March 22 2005

Fannie Mae has reduced almost all aspects of its mortgage activity and its exposure to the mortgage market – at an accelerated rate in February.
Fannie's business volume, the broadest measure of its mortgage market activity, fell to $40.167 billion in February from $48.101 billion in January. Those figures are well down from about the $75 billion of average business volume in April, May, and June of 2004.

Fannie Mae has to meet certain regulatory capital requirements by June 30, 2005. The Office of Federal Housing Enterprise Oversight (“OFHEO”) has directed Fannie to close a capital shortfall, caused by huge and dramatic adverse earnings restatements. But as Fannie indicated on March 17, certified financial statements will not be forthcoming for some time. While current financial statements are unavailable, Fannie will face great legal difficulties obtaining capital. New common stock issues are already out of the question, and even new preferred stock issue may not meet regulatory standards. Fannie's remaining alternative is to shrink its total asset base, which consists almost entirely of mortgages.

Accordingly, Fannie reduced its mortgage portfolio by about $15 billion in February to $875 billion. This comes to a 19% annualized rate of asset reduction. That's on top of January's $14 billion reduction. While significant, these reductions may still not be fast enough to bring Fannie into line with capital requirements. OFHEO has suggested that it may allow Fannie a further extension of time to meet those requirements. Even with those extensions, Fannie may eventually have to reduce its portfolio about 30% from the peak reached in October/November 2004 of $913 billion.

Fannie was the primary engine of the mortgage market, indeed even one of the main engines of credit creation in the US. Now it is going mostly offline for an overhaul. The banking and mortgage industry won’t be able to fill that credit creation gap. As Fannie's mortgage machine shrinks, we should expect new mortgage originations to slow down significantly. Even more significantly, its portfolio liquidations are likely to pressure systemic liquidity, a process which has already begun.


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