The Path for Housing GSEs and its Impact on Corporate Cash Investors

Abstract

Recent events related to government sponsored enterprise (GSE) reform have prompted short-duration investors to question the level and nature of government support for their debt issuance after December 31, 2012. The housing GSEs play a critical role in the U.S. mortgage market, representing 99% of all new mortgage-backed securities (MBS) issuance in recent years. Money market funds owned $402 billion in agency debt at the end of 2010, which accounts for approximately 15% of all fund assets, and direct holdings of agency debt doubled in corporate cash portfolios between 1Q 2009 and 4Q2010. Due to their current government debt classification, the sudden removal of U.S. Treasury support for GSE debt may pose systemic risk. Current and projected capital draws by their regulator indicate that Fannie Mae (FNM) and Freddie Mac (FRE) may not need additional Congressional capital appropriations after 2012. The government’s proposal to Congress also indicates its strong commitment to maintaining support. In conclusion, an expected lengthy political process, the possibility of grandfathering existing debt, and the short-duration nature of cash debt, should provide additional comfort to corporate cash investors.

Introduction

For decades, debt investors enjoyed implicit government guarantees on the senior debt of Fannie Mae and Freddie Mac. The guarantees became de facto explicit when the U.S. government became the conservator of the government sponsored enterprises during the financial crisis in September 2008. However, with a special provision for the government’s capital support agreements set to expire in December 2012, short-duration debt investors are beginning to face uncertainties regarding the extent and nature of that support after 2012.
Since the submission of the White House’s “Reforming America’s Housing Finance Market” proposal to Congress on February 11, 2010, discussions on the future of Fannie, Freddie and the U.S. housing finance market have intensified. While the direction of these discussions is likely to take many twists and turns in the years to come, we are particularly concerned with the future of the U.S. agency debt market should the GSE charters be revoked. To that end, this paper takes a very narrow focus on the following topics: the importance of GSE debt issuance to corporate cash investors, the likelihood and timing of changes in government support for GSE debt, and the ensuing implications for portfolio liquidity and credit quality.
We believe that the senior debt of the housing GSEs will continue to enjoy a very high level of government support after 2012 and believe that corporate cash investors should maintain their confidence in this asset class for the foreseeable future. The GSEs play a critical but complicated policy role in the housing market and we do not expect a speedy political resolution for these institutions. In fact, we think that a hasty revocation of government support may pose systemic risk to the U.S. financial system, thanks to the large presence of GSE government debt in money market funds.
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