London: Private investors will take over some of the risk of default on $22.5 billion (Dh82.6 billion) of mortgages currently guaranteed by US taxpayers, in a landmark deal designed to reduce the federal government’s outsized role in the country’s housing market.
Freddie Mac, the government-controlled mortgage finance giant, was on Tuesday close to finalising a deal to sell a new kind of derivative that regulators hope could entice private capital to shoulder losses when homeowners get into difficulties.
The bulk of new mortgages in the US are currently underwritten by a government guarantee, through Freddie Mac and its sister agency, Fannie Mae. The pair required $187 billion in bailout funds after coming close to collapse during the subprime mortgage meltdown.
Freddie is selling a new financial product it calls structured agency credit risk, or Stacrs, pronounced “stackers”, which will absorb some of the losses on a pool of government-guaranteed mortgages that it currently holds in its portfolio.
The size of the sale was increased to $500 million from $400 million to reflect additional investor demand after Freddie increased the yield it was willing to pay on the riskiest derivatives.
The Federal Housing Finance Agency, which regulates Fannie and Freddie, demanded that the two companies sell the default risk on at least $30 billion of mortgages in each of their portfolios this year. Fannie Mae is preparing its own risk-sharing experiment, which it is expected to take to investors in the autumn.
Freddie is selling two equal size tranches of Stacrs, with the riskiest $250 million paying a premium yield of 715 basis point above interbank rates, according to people familiar with the deal. Freddie will absorb losses up to 0.3 per cent of the $22.5 billion pool, holders of the first tranche will cover the next portion up to 1.65 per cent, and the second tranche will absorb further losses up to 3 per cent.
The 3 per cent cap was chosen because it reflects the losses on similar mortgages during the 2007-2011 downturn, leaving the government on the hook only in more extreme crises.
Freddie’s first deal, and the other experiments that will follow this year, represent a drop in the ocean in the $13 trillion US mortgage market, but it is hoped that they will help discover a market price for default risks that are currently borne by the taxpayer. The programmes could then be scaled up, in a bid to trim the scale of Fannie and Freddie’s involvement in the market.
Politicians have begun debating ways to wind down the two companies and to reduce the federal government’s role as backstop to more than half of the outstanding mortgages, including more than 90 per cent of new loans.
Proposed legislation has now been floated in both houses of Congress, though the Obama administration is yet to set out its favoured options.