Stresses on Fannie, Freddie pose wider risks
A recession could trigger a large rescue of Fannie Mae and Freddie Mac and result in a downgrade of U.S. debt, says rating agency.
WASHINGTON (AP) -- A deep recession could force mortgage-finance titans Fannie Mae and Freddie Mac to require a federal bailout large enough to hurt the U.S. government's top-grade credit rating, Standard & Poor's warned Monday.
A lower credit rating would mean higher borrowing costs for the U.S. government and could lead to a flight from Treasury securities, which investors - including foreign governments - consider to be virtually risk-free.
The financial stress Fannie (FNM) and Freddie (FRE, Fortune 500) face poses a far larger risk to the government than the $29 billion in mortgage assets taken on by the Federal Reserve to avoid the bankruptcy of investment bank Bear Stearns Cos, the credit rating agency said.
Still, S&P analysts see a bailout of Fannie and Freddie as unlikely and point out that U.S. officials "are focused on avoiding a deep and prolonged recession."
'Too big to fail'
While the government isn't obligated to assist Fannie or Freddie in a financial emergency, many on Wall Street believe it would bail them out if there is a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply by issuing top-rated securities backed by mortgages.
Aiding Fannie and Freddie, plus the government agencies that back home loans and student loans could add up to 10% of gross domestic product, the total value of all goods and services produced within the United States, S&P said.
John B. Chambers, chairman of Standard & Poor's sovereign rating committee, said in a statement that in a worst-case scenario the size of Fannie and Freddie "could create a material fiscal burden to the government that would lead to downward pressure on its rating."
Encouraged by regulators and politicians intent on keeping more homeowners from defaulting, Fannie Mae and its smaller government-sponsored sibling Freddie Mac have expanded their roles in the stricken housing market. The companies together must provide as much as $200 billion in new funding for home loans in exchange for getting their risk cash cushions reduced.
The government requires them to keep a certain amount on reserve to guard against risk.
Over the past year, Fannie and Freddie's share of new mortgages has been soaring, as Wall Street investors have backed away from all but the safest mortgage-related securities. Their market share of new mortgages rose from 46% in the second quarter of 2007 to 80% in January, S&P said.
Fannie and Freddie "face heightened demand to provide mortgage financing, which comes at a time when their need to raise capital and improve earnings has placed them under extreme pressure against the backdrop of historically weak housing markets and seized [mortgage-investment] markets," S&P credit analyst Victoria Wagner said in a statement.