Investors have already been warned by the government-sponsored mortgage companies that credit-related losses, such as payouts on loans they guarantee, would likely continue to rise throughout the year in the face of declining prices for U.S. home prices that are pushing defaults on mortgages.
However, last month’s catastrophic collapse in the mortgage companies’ shares, prompting the U.S. Treasury and Congress to extend a lifeline of government support to both Fannie Mae and Freddie Mac, is an indicator that investors think the two companies severely underestimated the housing market crisis.
The U.S. housing market has continued to slide downhill since the two companies' posted their forecasts three months ago, leading Standard & Poor's last week to raise its loss estimates on risky loans which, in a sort of domino effect, could continue and exacerbate the negative cycle of asset write-downs at banks.
In the market's view, Fannie Mae and Freddie Mac may not have enough capital to offset losses and maintain their roles as the engines that drive the U.S. housing market.
According to Robert Napoli, an analyst at Piper Jaffray in Chicago, Illinois, Fannie Mae and Freddie Mac have "increased credit loss expectations for the past three quarters and this next one is probably going to be the fourth." Freddie Mac, which projected in May credit losses of 16 basis points for the year, is expected to report second-quarter results on Wednesday. Meanwhile, in May, Fannie May increased its forecasting for its 2008 credit loss ratio to 13-17 basis points, at least twice its historical range. Fannie Mae has not yet set a date for reporting its second quarter results.
Should the mortgage companies continue to make upward revisions to its loss forecasts, fear and scrutiny may spark all over again about whether the two companies are able to can contain their losses and meet political pressure to expand their support for the housing market.
Doubts about the adequacy of their capital adequacy led to the U.S. Treasury to formally and explicitly establish its already tacit support for the two companies. The housing market legislation passed by Congress in July included provisions for the U.S. Treasury to buy equity capital in the two firms and extend credit to them.
Despite the uncertainty swirling about them, both Fannie Mae and Freddie Mac have said they have enough capital — a statement affirmed by their regulator, OFHEO.