Mortgage modifications may rise

SAN FRANCISCO – The government’s decision to provide unlimited support to Fannie Mae and Freddie Mac probably is a sign of more aggressive action in the future to prop up the U.S. housing market.

The government may put a mortgage-modification effort, called the Home Affordable Modification Program, or HAMP, into overdrive in coming years, pushing for reductions in the principal outstanding on home loans overseen by Fannie and Freddie, Bose George, an analyst at Keefe, Bruyette & Woods, wrote in a note to investors Monday.

The U.S. Treasury Department said on Christmas Eve that it lifted $200 billion caps on the amount of taxpayer money that can be pumped into the ailing mortgage giants over the next three years.

Neither institution is near its $200 billion limit – Treasury has put $60 billion into Fannie and $51 billion into Freddie since it seized the failing companies in September 2008.

However, Treasury said the promise of unlimited government money “should leave no uncertainty about the Treasury’s commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”

KBW’s George initially found the extra support “perplexing,” he said, because Fannie and Freddie are unlikely to need more than $200 billion of government money each.

During the depths of the recession in March 2009, the Government Accountability Office estimated that the bailouts of the two companies would cost taxpayers $389 billion, the analyst noted. Since then, house prices have stabilized and have begun to creep up in some areas.

Instead, unlimited taxpayer support will give the government “more flexibility in potentially taking more aggressive action to support the housing market,” George wrote.

HAMP has so far had little effect on foreclosures. So the government may push for an enhanced version of the program that includes reductions in the principal outstanding on mortgages, the analyst said.

Principal reductions are controversial because they leave banks and other major mortgage lenders with bigger losses and lessened capital. The industry prefers modifications that lower interest payments in other ways, such as extending the maturity of home loans.

Aggressive reductions in principal on mortgages overseen by Fannie and Freddie could leave the companies with significant losses and cut further into their waning capital bases. But Treasury can pump more money into the institutions to make up for that, George said.

Mortgage-backed securities held by private companies are trading at big discounts, so write-downs from principal reductions may not have a big impact in this part of the market, George added.

However, Fannie and Freddie hold mortgage securities in their portfolios at original cost. So write-downs from principal reductions could “meaningfully impact earnings and capital,” the analyst said.

The government’s original bailout of Fannie and Freddie required the companies to start cutting their portfolios of retained mortgages by 10 percent a year starting in 2010. That’s because rampant growth earlier this decade was partly responsible for the companies’ collapse last year.

However, Treasury said on Christmas Eve that the 10 percent reduction in 2010 will be based on the maximum allowed size of their portfolios, which is $900 billion, not the actual size, which was roughly $770 billion at the end of October, George noted.

This means Fannie and Freddie won’t have to cut their portfolios in 2010 and will only modestly reduce them in 2011, the analyst said.

Fannie and Freddie were also due to pay a commitment fee to the Treasury, starting in the first quarter of 2010. Treasury postponed that for a year, which should give the companies’ earnings and capital a boost, according to George.