I am sure you have all read by now that the US Treasury Department has effectively “seized” control of the two US home mortgage market corporations - the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Me) - and placed them under the oversight of the Federal Housing Finance Agency (FHFA). The FHFA was created earlier this year when President Bush signed the Housing and Economic Recovery Act of 2008. Today’s move marks what is likely to be the final act in Federal intervention in the home mortgage market (in part because few options remain) and will likely cost the taxpayers 200B dollars - or about one year of combat operations in Iraq.

The question is - will it be enough? And the other question is - enough to do what? Put the market back on its feet or ensure the entire market continues to function?

First, I think you need to just ignore Hank Paulson (Secretary of the Treasury for those who don’t know) and others in saying this won’t cost the taxpayers. It will. How much, how long, and what Fannie and Freddie will be at the end of this mess are questions that must be answered by the next Administration. For now, Uncle Sam is now in the mortgage loan business… but in it to do what, exactly?

The Treasury’s move doesn’t answer what could be the $5 trillion question of what ultimately happens to Fannie and Freddie. Under the conservatorship of the FHFA, the companies will still have their shares listed on the New York Stock Exchange, but management control goes to the regulator until it deems the companies financially healthy. Congress ultimately will have to decide in what form Fannie and Freddie will be relaunched or whether they will be replaced by different types of entities. Moreover, the market listing of the FHFA shares looks like it will severely penalize, in terms of market value and market dilution, shares held by thousands of small and medium-sized banks, while protecting some of the larger bondholders (mostly mutual fund investors, US government retirement funds, and large corporate retirement funds) from complete meltdown of the Freddie/Fannie portfolio vlaues. In short - putting the two companies into receivership and then putting the FHFA stock on the market doesn’t look like it will slow down the market freefall on mortage paper.

Paulson refused to say how much capital the government might have to provide or what the cost to taxpayers might ultimately be. The companies are likely to need tens of billions of dollars over the next year, but the cost to taxpayers will largely depend on how fast the housing and mortgage markets recover.

Paulson’s plan begins with a pledge to provide additional cash by buying a new series of preferred shares that would offer dividends and be senior to both the existing preferred shares and the common stock that investors around the world already hold.

The two companies will be allowed to “modestly increase” the size of their existing investment portfolios until the end of 2009, which means they will be allowed to use some of their new taxpayer-supplied capital to buy and hold new mortgages in investment portfolios.

However, I believe that a strong indication of Paulson’s long-term intentions are to wind down the companies’ portfolios, drastically shrink the role of Fannie and Freddie, and perhaps eliminate their unique status altogether. Paulson’s plan calls for the companies to start reducing their investment portfolios 10 percent a year, beginning in 2010.

Thus, the long-term plan may be to put Uncle Sam in the mortgage business whole hog now - in order to try to pull him out entirely in less than 2 years. I find neither scenario all that appealing. The reality is, without a quasi-governmental entity to make a secondary market for mortgage-backed securities, the ability of people of all income levels to finance home purchases will be considerably more difficult.

Today’s move was inevitable with the signing of the Housing and Economic Recovery Act of 2008. However, today’s move raises more questions than it solves - Freddie and Fannie may no longer be in a market free fall - but how to put them back up on their feet is far from clear.

Possibly Related Posts:

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• World Leaders panic while Washington Fiddles and the Financial Markets Burn!
• House bailout bill goes BUST! Now what? Recession? Economic Collapse? Wall Street Implosion? Mass Hysteria?
• Reform, not Rescue… Buy in, not Bail Out.