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Wall Street Whispers: Fannie, Freddie Are Liquidating (Kind Of)

WASHINGTON (TheStreet) -- Republicans who have made much ado about their desire to liquidate Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB) might be surprised to learn that it's already happening - at least in part.

In fact, the main impediment to progress on the liquidation front has been private investors' buyback demands.

As required by their bailout agreement, the government-sponsored enterprises (GSEs) are already in the process of liquidating their so-called "retained" mortgage portfolios. Their chief regulator, the Federal Housing Finance Agency, isn't allowing the two companies to be in the market as active buyers of new mortgage assets for their own portfolios. Instead, Fannie and Freddie have been acting as conduits between mortgage originators and private investors who still need the assurance of government backing to do business with one another.

The original bailout of Fannie and Freddie, sketched out by former U.S. Treasury Secretary Henry Paulson, required the firms to start winding down by 10% a year, starting in 2010, until their portfolio sizes reached a relatively meager $250 billion apiece. But, as the "liquidation" process has moved forward, a few things have gotten in the way.

First, accounting rule changes brought more assets onto the GSEs' balance sheets than they had at the time they entered conservatorship in September 2008. Paulson's successor, Timothy Geithner, took care of that problem. In removing their bailout cap last December, Geithner made a few tweaks to the bailout agreement. The changes effectively slowed the liquidation process and made it easier for Fannie and Freddie to adapt to FAS-166/167 accounting rule changes.

In altering the terms, the Treasury Department said it was trying to make the liquidation process "less burdensome and more transparent in light of impending accounting changes." It also reiterated the fact that Fannie and Freddie are not expected to be active buyers, but "neither is it expected that active selling will be necessary to meet the required targets."

In other words, the write-downs and foreclosures related to mortgage defaults would help take care of the liquidation requirement for the foreseeable future.

Indeed, the two firms appear to be on track to have met the 10% liquidation requirement by the end of December. Freddie said in its quarterly report this week that its portfolio has declined by 6% so far this year - or 8% at an annualized rate - "primarily due to liquidations." The liquidation rate might be higher if not for Freddie's requirement to buy back nearly $390 billion worth of seriously delinquent mortgages from private trusts so far this year.

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