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Busch: Treasury's Xmas Present to Fannie and Freddie

Yesterday, I tweeted about the Christmas Eve decision by the Obama administration on Fannie Mae and Freddie Mac. The cap to lending to these two mortgage giants was lifted and could cover unlimited losses over the next three years. The US Treasury receives preferred stock in both companies paying 10% dividends. Already, the US has paid out $111 billion: $60 billion to Fannie and $51 billion to Freddie. The previous cap was $400 billion. Treasury said that this was "necessary for preserving the continued strength and stability of the mortgage market."

Why was this done at this time? The driver was a December 31st expiring agreement that allowed the US Treasury to make amendments to the original September 2008 conservatorship deal. The Treasury had the authority to make changes by the end of 2009 without the consent of Congress. Given the fight over extending the debt ceiling, this would likely have been another major battle.

Back in October, I met with the top US Treasury officials on a number of topics. When the subject of Fannie and Freddie came up, they said that there was no oxygen at this time to deal with them. It was more likely that something would be accomplished in February. Apparently, they must have changed their mind when they realized how fractious Congress was becoming over health care.

The bigger question remains unanswered: Will the Obama administration begin the process of winding down these institutions? The combined mortgage portfolios of these companies is $1.6 trillion. Fannie and Freddie's debt doesn't show up on the nation's debt totals, but the US taxpayer is on the hook due to the "conservatorship" agreement. This is why these two companies can keep coming back for money to shore up their declining loan portfolio.

The yield spread between these agencies and similar US Treasury debt compressed when the Federal Reserve began it's quantitative easing program. The Fed will complete this $1.25 trillion mortgage purchase program by April. Given the current trajectory of the recovery coupled with the ending of QE, we could see a significant rise in US Treasury rates and even higher US mortgage rates.

This is likely why we are currently hearing calls for significantly higher rates from US investment banks.........and by Freddie Mac's economist. Can there be a bigger red flag than this?

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Andrew B. Busch is Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.