Investors in the two government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae got their hopes up early in the week based on speculations that federal regulators - specifically the Office of Federal Housing Enterprise Oversight (OFHEO) - might allow the two mortgage giants to buy more home loans in an effort to shore up what has become a catastrophic residential credit market.

Stocks in both GSE's climbed Monday and Tuesday on unconfirmed rumors that Fannie Mae had requested that restrictions on its portfolios be lifted. Senators Christopher Dodd and Charles Schumer also called on federal regulators to ease restrictions on both GSE portfolios.



Ever since Freddie and Fannie ran into trouble with federal regulators, the Securities and Exchange Commission (SEC) and the New York Stock Exchange over their accounting practices three years ago there have been calls from Republican members of Congress, the Administration, and two different Federal Reserve chairmen to limit the multi-trillion dollar residential loan portfolios owned by the two GSEs. Essentially those opposed to Freddie and Fannie feel that (a) they have not necessarily acted as effective stewards and (b) they have an unfair advantage over their private market competitors. As far back as 2005 President Bush spoke out against the large portfolios maintained by the two firms.

Still, the current situation is extraordinary as we have watched probably well over a dozen mortgage companies either bite the dust or severely restrict their lending. Two Bear Stearns hedge funds ran into trouble last month and one folded and there is new word that a Goldman Sachs fund may also be in trouble. The severe drop on Wall Street Thursday was started by word from France that one of its main players, BNP Paribas, admitted it did not know what its exposure might be to the American subprime market and therefore closed trading in three of its funds because it had no idea how to assess their value.

Anecdotal information about the residential credit markets is not reassuring; we are hearing that money simply is not there to fund loans that have been in the pipeline unless they are pure vanilla loans with an extra scoop of ala mode. After the markets closed on Thursday Countrywide Mortgage, one of the nation's largest lenders, admitted it might not be in as good a shape as it had claimed earlier in the week.

OFHEO has remained quiet on suggestions about GSE expansion. Its director, James Lockhart has long opposed anything but a reduction in Freddie and Fannie's portfolios. And in a quite remarkable press conference on Thursday, President Bush stated flatly that both corporations need to be reformed and streamlined before they're allowed to buy more loans and that the free market is better equipped to handle the situation.

Thursday the European Central Bank (ECB) and Bank of Canada both stepped in to assuage fears of a credit crunch that are roiling the international markets. ECB loaned 95 billion euros (the equivalent of $131 billion USD) to 49 banks and the Bank of Canada said it would "support the stability of the Canadian financial system and the continued functioning of financial markets. The Bank is closely monitoring developments, and will deal with issues as they arise." The ECB one-day quick tender exceeded the record 70 billion euros it provided in the wake of 9/11. The ECB injected an additional 61.05 billion euros into the system on Friday, which appeared to steady panicky markets.

The Federal Reserve also stepped up both Thursday and Friday, pumping billions into the system. The Fed said it stood ready to provide emergency funds to banks and that it would do whatever was necessary to keep markets from what Reuters called "seizing up."

Reuters said that such statements from the Fed are unusual, with the last having come after the September 11, 2001, terror attacks, and reflect the seriousness that policy-makers view the current disorder in the markets.

The press service said that central banks worldwide have injected at least $323.3 billion into credit markets in the past 48 hours.

In an editorial on Friday The New York Times endorsed an effort to allow Freddie and Fannie to infuse money into the mortgage market but stressed that they should be required to use that enhanced capacity to help homeowners rather than lenders. The Times said that the GSEs should buy loans only from lenders who commit to using the fresh capital to refinance borrowers who are in trouble and to pressure lenders to do more to restructure existing loans by extending the term of the low teaser rates that originally lured borrowers or to raising interest loan rates on adjustable rate loans in digestible steps rather than all at once.

The editorial stated that "Many strapped borrowers stuck in subprime loans, with adjustable rates that reset sharply upward, could have qualified for higher quality loans to begin with. Instead they were steered into the subprime variety by brokers who earned bigger fees by making dodgier mortgages. Now that the lenders are suddenly in trouble and credit standards have been tightened, those borrowers cannot refinance into higher quality, more affordable loans. They clearly deserve help to keep their homes.

"In other instances, borrowers who had weak credit a few years ago and so had no choice but to take out subprime loans, now have track records of good payments. They, too, should be allowed to refinance into loans that would let them keep their homes."