Please refer to important disclosures and analyst certification information on pages 12 - 15.Page 2
The Future of the GSEs: A Government Exit Strategy to Recapitalize Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac have been at the heart of the U.S. housing boom, bust and recovery. Since being put intoreceivership last summer, the U.S. government has put $98 billion of capital into the two organizations and their guaranteehas become more explicit. The combination of increased support for the GSEs and the slowdown in originations in theprivate sector has resulted in the GSE volume growing sharply. Fannie Mae and Freddie Mac accounted for 68% of alloriginations in 2009. (The government's Federal Housing Administration program accounted for a large percentage of theremainder.) Exhibit 1 shows the historical market share of the GSEs.
Exhibit 1: GSE Market Share Growth
0%20%40%60%80%100%90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Note: 2009 data is for 1H09.Source: Inside Mortgage Finance.
As James B. Lockhart III—the Director (CEO) and Chairman of the Oversight Board of the Federal Housing FinanceAgency that was the regulator of Fannie and Freddie at the time of conservatorship—stated when the U.S. governmentseized them, "Fannie Mae and Freddie Mac are no longer in the business of maximizing shareholder value." Rather, in ourview, the two agencies are now in the business of stabilizing the U.S. housing market.Thus, Fannie Mae and Freddie Mac today are acting as a direct arm of the federal government providing massive federalaid to support and revive the U.S. housing market in the midst of a crisis. At the same time, their operating structure is asprivate companies operating under the conservatorship of the U.S. government. This is not a sustainable structure as isdocumented in a recent report from the Government Accountability Office ("Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing Enterprises' Long-term Structures" dated September 10, 2009).
The Problem of Capital
The GAO report presents options for Fannie and Freddie ranging from becoming full government entities to returning tobeing stock-holder corporations. What the GAO report is missing, in our view, is addressing the most crucial issueregarding the agencies: how to recapitalize them.There are three financial issues of note that we believe help define the restructuring needs of the two agencies:
Operating under conservatorship, Fannie and Freddie create an unlimited government liability, as evident by the GAOestimated need of $389 billion government support;
Accounting changes will balloon the balance sheets of the two companies to approximately $5.5 trillion in 2010 fromunder $2 trillion today as a result of FAS 166/167, illustrating the capital needs of the companies; and
October 19, 2009An Augean Task: A Government Exit Strategy to Recap FNM & FRE