For more than a decade, Fannie Mae and Freddie Mac, the housing giants that make the American mortgage market run, have attracted overseas investors with a simple pitch: the securities they issue are just as good as the United States government’s, and they usually pay better.
The marketing plan worked. About one-fifth of securities issued by Fannie , Freddie and a handful of much smaller quasi-governmental agencies, some $1.5 trillion worth, were held by foreign investors at the end of March. One out of 10 American mortgages is, in effect, in the hands of institutions and governments outside the United States.
Now that the two companies are at risk, how their rescue is handled will ultimately test the world’s faith in American markets. It could also influence the level of interest rates and weigh on the strength of the dollar for years to come, analysts say.
“No less than the international perception of the credit quality of the U.S. government is at stake,” said Richard Hofmann, an analyst with CreditSights, an independent research house with offices in London and New York.
Also at stake is Americans’ future ability to gain access to credit. If foreign companies and governments abandon United States investments, home, auto and credit card loans will be much more difficult to come by.
That helps explain why Treasury Secretary Henry M. Paulson Jr. is pressing American lawmakers for the authority to inject unspecified billions in cash into either company or both. The “blank check” nature of his request has raised concerns on Capitol Hill, but Mr. Paulson is betting that Congress is even more fearful of the consequences of doing nothing to rescue Fannie and Freddie.
On Sunday, in an appearance on the television program “Face the Nation,” Mr. Paulson said he was “very optimistic that we’re going to get what we need from Congress.”
“Congress understands how important these institutions are,” Mr. Paulson said.
Asian institutions and investors hold some $800 billion in securities issued by Fannie and Freddie, the bulk of that in China and Japan. China held $376 billion and Japan $228 billion as of June 2007, the most recent country-specific Treasury figures.
In Europe, roughly $39 billion in Fannie and Freddie debt is held in Luxembourg and $33 billion more in Belgium, countries that are home to large investment management firms. Investors in Britain hold $28 billion, and Russian buyers hold $75 billion. Sovereign wealth funds in the Middle East are also believed to be big investors in Fannie and Freddie debt.
The trillions in securities issued by Fannie and Freddie and backed by American mortgages were never explicitly guaranteed by the United States government, but foreign and domestic investors alike have always believed, because of the companies’ integral role in the housing market and their marketing pitch, that the guarantee would be backed up if it were tested.
As the United States government’s debt, and the corresponding amount of Treasury securities, shrank in the late 1990s, foreign investors with currency reserves needed a safe alternative to park their cash. Fannie and Freddie stepped up their overseas marketing efforts and, with the help of Wall Street banks, sold billions of dollars in securities overseas.
Asian banks and insurers bought Fannie’s and Freddie’s paper because it gave a little more yield than a straight Treasury note — “the same risk at a better price,” said Deborah Schuler, an analyst with Moody’s Investors Service in Singapore.
Investment managers at Asian banks and central governments are “very comfortable with the idea of implied government support” because it is so prevalent in Asia, Ms. Schuler said.
Still, this week’s Congressional debate on the issue “is going to worry people,” Ms. Schuler said, though she, like most analysts, is confident that Washington will deliver, just as it has in past financial crises like the savings and loan industry bailout of the late 1980s and early 1990s.
Because America’s relations with a host of countries are intricately tied to Fannie and Freddie, the only realistic option open to lawmakers may be to hand the Treasury Department that blank check, analysts say.
The two housing agencies have always been fierce competitors, and they made no exception in their expansion into international markets. Top executives wooed governments, banks and insurance companies in Asia and Europe, and lent executives to help foreign governments, including Russia and Hong Kong, set up their own American-style mortgage markets.
Trouble at Fannie and Freddie Stirs Concern Abroad
Both companies often compared their product to United States Treasuries when they talked to international investors, and adjusted the way that bonds matured and were priced so they looked and acted more like Treasury bonds.
In an interview with a London financial trade paper in 1999, Jerome T. Lienhard, Freddie Mac’s senior vice president of investment funding, said, “Investors that make the transition from U.S. Treasuries to our securities will be pleased with the performance.” Freddie Mac’s program is “designed to mirror that already used by the United States government,” he said.
The Treasury will not comment on Fannie and Freddie’s international marketing pitches, but in the past it has tried to rein in the two institutions.
In March 2000, Gary Gensler, then Treasury under secretary, proposed more oversight of Fannie and Freddie, testifying to Congress that the two agencies “receive no funds from the federal government, and the government does not guarantee their securities.”
The companies “have been promoting their debt securities as an alternative market benchmark” to Treasuries, he noted, particularly as the amount of Treasuries issued by the government shrank with the deficit. Mr. Gensler’s comments roiled mortgage markets, sending prices down sharply on traded Fannie- and Freddie-backed securities and on both companies’ stock. Ultimately, the controls he proposed were softened.
The bulk of investments related to Fannie and Freddie are in the form of mortgage-backed securities, often called agency securities or agency paper. This agency paper is considered of much higher quality than securities backed by subprime loans because Fannie and Freddie generally lend to borrowers with good credit histories and require higher down payments.
Prices on senior Fannie and Freddie securities, the highest quality, have not changed significantly since the end of last year, even as the two companies’ stock prices have plummeted, Moody’s noted. As of June 30, 2008, prices on a typical Fannie or Freddie security maturing in 10 years were off only about 2 percent from December 2007.
Questions about Fannie and Freddie have prompted individual institutions and governments in Asia and Europe to specify their exposure in recent days, but so far international concern has been limited. Ingo Buse, a spokesman for Zurich Financial Services, Switzerland’s largest insurer, said it held $8.3 billion in mortgage securities backed by Freddie Mac or Fannie Mae, and felt “comfortable with our position and asset allocation.”
Swiss Reinsurance, Switzerland’s largest reinsurer, said on Wednesday that it held $9.6 billion of corporate debt from Freddie Mac and Fannie Mae and $12 billion in mortgage securities backed by the two companies. Swiss Re’s holding of Freddie Mac and Fannie Mae shares is minimal, it said.
Hannover Re, Germany’s second-largest reinsurer after Munich Re, said it held 125 million euros, or $199 million, in securities issued by Freddie Mac and Fannie Mae. “We are not worried about the exposure,” said Stefan Schulz, a spokesman for the company, “because we expect the U.S. government to step in if there is any problem.”
Julia Werdigier contributed reporting.