Concern over what the future holds for government-sponsored enterprises Fannie Mae and Freddie Mac has been heightened this week after the stocks of the two companies fell drastically yesterday, with Fannie falling as much as 24 percent and Freddie falling as much as 34 percent, their lowest point in 17 years, according to Bloomberg News.

This dramatic decrease, coupled with the overall year-to-year losses of both companies has led many to speculate if the federal government will soon take control of both companies, tapping into conservatorship powers granted to GSE regulator Office of Federal Housing Enterprise Oversight (OFHEO). In response to these rumors, and to lessen the probability that such talk will further decrease the stocks' value, OFHEO released a statement to assure the public that both Fannie and Freddie are still viable. James Lockhart, OFHEO director commented that both Fannie and Freddie are, “adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums. They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.” To back up this statement Lockhart pointed to the fact that Fannie Mae had raised $7.4 billion in May, and together Fannie and Freddie have raised over $20 billion in capital this year, with Freddie still committed to raising an additional $5.5 billion.

OFHEO's Comments Generate Criticism

Josh Rosner, managing director at Graham Fisher & Company, a New York-based independent financial service research firm, responded to OFHEO's statement by saying that he feels watching the markets is a better indication of the GSEs true capital. “While administration officials continue to claim the companies are adequately capitalized the markets do not believe this. We (Graham Fisher & Company) believe that the markets are right. For example, both GSEs have changed their servicing practices over the past year in a manner which reduces the current drain on capital but may ultimately increase the severity upon loss to the companies,” said Rosner.

What Rosner is referring to is the fact that both companies have implemented creative strategies in recent months to, as Rosner terms it, “hide the problems at the companies.” Such practices include no longer buying loans out of MBS pools at 90-days delinquent, but rather paying periodic payments to the pool. This saves Fannie and Freddie from having to assume the full costs that a buyout would entail. However, Rosner points out that although this stops the current cash burn the GSEs are experiencing in the long term such a delay causes larger losses as the prices of these homes fall further as the homes fall into disrepair. “Moreover, this approach reduces the ability of the GSEs to make insurance claims against the thinly capitalized private mortgage insurers who insure nearly $1 trillion of GSE exposures. By pushing the losses into the future it also increases the risk that the mortgage insures will have less claims paying resources available at that future date as other PMI insured's (private label) continue to foreclosure and make insurance claims,” Rosner said.

Rosner also criticized Fannie's HomeSaver Advance program which allows the company to make personal loans to homeowners with negative equity, effectively allowing them to move into the primary consumer lending market, something which is prohibited's charter. This program has, “the effect of hiding losses while likely increasing the ultimate loss severity.” said Rosner. “This obscures the real financial picture of their health and we do not understand why HUD as mission regulator, has allowed this unsafe practice that appears to violate their charter to occur. It would be helpful if, rather than turning a blind eye to reality, the government would recognize the reality of the situation, not try to falsely assuage rational concerns and would inform investors with an eye to a rational calming of fears through a reduction in uncertainty.”

Treasury Secretary Paulson Weighs In

Despite these criticisms, Treasury Secretary Henry Paulson thanked Congress for moves they are making to help the two GSEs. “We appreciate Congress' important efforts to complete legislation that will help promote confidence in these companies. We are maintaining a dialog with regulators and with the companies. OFHEO will continue to work with the companies as they take the steps necessary to allow them to continue to perform their important public mission.” Paulson said.

The idea of legislation, however, may raise more concerns than the desired effect of alleviating fears. Recently, the Senate resumed votes on a bill that would set up a housing trust fund that would collect $530 million a year through a levy on the two GSEs. Matt Kibbe, president of FreedomWorks, criticized the mortgage bailout legislation saying, “Rome is burning, and the Senate is adding lighter fluid. The GSEs represent a profound systemic risk, and investors are clearly concerned, yet Congress is moving to pass a bill that may make matters worse. This bill is advertised as strengthening regulation of the GSEs, yet imposes a permanent new levy that will materially undermine Fannie Mae and Freddie Mac.”Rachel Daniels