Wall Street Whispers: Pink-Sheet Politics

NEW YORK ( TheStreet) -- The most startling element of a panel discussion about the future of government-sponsored enterprises Fannie Mae ( FNMAS.OB) and FMCC.OB ( FRE) on Tuesday was the utter lack of direction from Washington on what to expect.

As a result, there wasn't much to discuss besides hypotheticals to the degree that one representative of a large buyer of Fannie/Freddie securities sounded as though his preference was irrelevant.

"I don't know what the answer is to GSE reform; what's your policy objective?" asked Jay Diamond, managing director of Annaly Capital Management ( NLY) at the panel discussion organized by SIFMA, the securitization industry's main trade group. Diamond later added: "The market will adapt to any change."

Annaly Capital is a mortgage REIT that holds roughly $70 billion in mortgage-backed securities. Diamond appeared to be the most frank about potential outcomes: If government doesn't stay heavily involved, rates will go much higher; if the government exits housing finance entirely, there may not be buyers for mortgage securities and credit may dry up entirely; if the government remains heavily involved in the mortgage market as the explicit, primary buyer and guarantor, there's moral hazard and the whole can of worms that comes with it.

Phew.

In any case, one can tell how momentous the task ahead of the government is and how serious its decisions may be. Another panelist, Mahesh Swaminathan, who oversees Credit Suisse's ( CS) strategies for investing in residential mortgage-backed securities, predicted that $3.5 trillion to $4.5 trillion in financing would "disappear" if the government rescinded its support, either implicitly or explicitly.

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So many issues came up in a short discussion that it was hard to decide what were the most important.

Do traditional, 30-year fixed mortgages make sense when few homeowners today are looking to keep one home for that long and interest rates change so dramatically in a much shorter period of time?

Can the U.S. handle a serious overhaul of housing finance -- whether covered bonds, complete privatization or a mortgage-welfare-state of sorts?

If not, will we just go through the same thing all over again?

These are all questions that the Obama administration and key lawmakers like Barney Frank (D., Mass.) have surely been asking themselves. Republican lawmakers have stood out front on the Fannie-Freddie issue -- which is arguably a good thing for all those involved -- but it's not clear whether the issue yet resonates with average consumers.

Still, the reason Fannie and Freddie reform is so important is that the companies represent the largest government bailout to date, with more taxpayer funds sure to be required to plug their balance-sheet gaps. Furthermore, the government is using the two agencies as cogs in the housing-recovery plan to lower rates, force banks to take back poorly underwritten mortgages and sue Wall Street firms over securitization practices.

All of these are reasons why the futures of Fannie and Freddie are important to both taxpayers and investors: One is footing the bill, the other is trying to figure out whether banks will be able to earn as much money from housing finance and securitization as they had in the past.

But the fact that we're approaching the two-year anniversary of the government's takeover of Fannie Mae and Freddie Mac -- which were essentially bankrupt, or would have been by now without taxpayer support -- and no definitive plan or hint of a plan has been indicated is truly disturbing.

The Mortgage Bankers Association proposed a plan for Fannie and Freddie that isn't much different from its current form, as did the Center for American Progress, which is said to have Obama's ear more than other Capitol Hill think tanks. (Biggest change: Explicit guarantee on debt vs. implicit.)

Another panelist, Bert Ely, who has been involved in the financial industry for decades, used the discussion to promote his support of covered bonds. But unfortunately, the move from MBS to covered bonds would require so many things -- from investor comfort to an overhaul of the U.S. mortgage finance system -- that no other panelist could support covered bonds beyond a "component" of the U.S. housing finance system with slightly more influence than it once had.

Ann Schnare, a consultant on affordable housing, may have made the most dead-on remark of the session beside Diamond. Whatever the Obama administration and lawmakers use as their goals, the market will adapt to, eventually. But because of the politics of the Fannie-Freddie issue -- lawmakers will not only have to explain what the housing-finance giants do, but how they plan to change that -- Schnare doesn't expect a whole lot to change.

"We probably will get a slightly altered version of the status quo," said Schnare. "And that won't help the American populace very much."

The reason, according to various sources, is that the government needs Fannie and Freddie too much to let them go. The two entities now control a wide majority of the U.S. mortgage market, keep rates low to foster a housing recovery and since the government has stood behind the GSEs so far, the impact of stepping away could be more dire than mortgages.

"If the government in any way stunned investors in GSE debt, it would halt their ability to sell Treasury debt," noted Ely.

Still, at some point, the government has to let everyone know what's going on with Fannie and Freddie. It's likely, as Schnare suggested, that not a whole lot will change -- Treasury Secretary Tim Geithner indicated that the government will remain involved in the mortgage market, but simply change its GSE guarantee to an explicitone. But if not much is changing, what's taking so long to say so?

Meanwhile, Fannie and Freddie's essentially worthless shares had been bouncing around on the New York Stock Exchange, where speculative traders have had a field day. Instead of coming up with a comprehensive plan for Fannie and Freddie, their regulator, the Federal Housing Finance Agency, recently placed the two stocks -- which had long been threatened for disqualification by the NYSE -- on the pink sheets. They now trade as FNMAS.OB and FMCC.OB rather than FNM and FRE.

-- Written by Lauren Tara LaCapra in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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