Hot day for wards of the state as Fannie, Freddie, AIG soar

Trading has turned wild today in shares of the three financial giants majority-owned by Uncle Sam.

Shares of Fannie Mae and Freddie Mac have jumped more than 30% after rumors hit the market that the companies’ chief regulator, James Lockhart, is expected to resign.

American International Group has soared more than 50% after Radian Group Inc., which competes with AIG in the mortgage-insurance business, reported a surprising second-quarter profit.

Fannie Mae was up 18 cents, or 31%, to 75 cents at about 12:20 p.m. PDT; Freddie Mac was up 19 cents, or 31%, to 80 cents.

As with all penny stocks, Fannie Mae and Freddie Mac now are the realm of rank speculators, who may be betting that Lockhart's departure will move the government closer to deciding on the long-term fate of the businesses. The U.S. owns about 80% of both companies after declaring them insolvent last September.

The jump in AIG -- up $7.62, or 56%, to $21.14 -- may at least reflect more optimism about a fundamental part of the insurance titan’s business, after Radian’s report. AIG will report its second-quarter results Friday.

But AIG, too, is 80% owned by the government. The company is selling off pieces of itself to repay federal bailout loans, but outgoing CEO Edward Liddy told shareholders at the annual meeting June 30 that he could offer "no assurances" on how soon the government’s stake in the firm would be reduced.

A Citigroup analyst early last month said there was a 70% probability that AIG’s remaining public shareholders would be wiped out.

AIG has been a favorite target of "short sellers" who have been betting that the stock would continue to slide. The surge in the price today suggests that some of the shorts are scrambling to buy shares to close out their bets -- a classic "short squeeze."

-- Tom Petruno

U.S. may slap fees on financial mega-firms to cut failure risk

How to deal with the vexing "Too Big To Fail" or "Too Complex to Fail" problem in the financial industry: Impose a TBTF/TCTF fee.

That is Federal Deposit Insurance Corp. Chairwoman Sheila Bair's proposal, and it appeared to be embraced by President Obama at his news conference late Wednesday.

From Bloomberg News:

President Obama signaled support for a proposal to impose fees on some of the nation’s largest financial firms to cover losses from risky transactions and avert another market meltdown.

Obama, at a White House news conference last night, said the U.S. may need a mechanism similar to the Federal Deposit Insurance Corp. for firms that engage in “some of these other far-out transactions” that put the financial system at risk.

“So if you guys want to do them, then you’ve got to put something into the kitty make sure that if you screw up, it’s not taxpayer dollars that have to pay for it, but it’s dollars coming out of your profits,” he said.

Bair, who will testify before the Senate Banking Committee today, is expected to call for the creation of a Financial Company Resolution Fund that would provide capital if the government has to step in and unwind a major financial institution -- presumably other than a big bank that would be covered by the FDIC's fund.

The collapses over the last year of Bear Stearns Cos., Fannie Mae and Freddie Mac, Lehman Bros. and insurer American International Group pointed up the government's need for a strategy to deal with the demise of huge non-bank firms whose troubles pose massive risks to the entire financial system.

From Bloomberg, which got an advance copy of Bair's testimony:

The government should impose “assessments on large or complex institutions that recognize their potential risks to the financial system,” Bair said. “This system also could provide an economic incentive for an institution not to grow too large.”

She urged the creation of a mechanism to wind down “large, systemically important financial firms” with no cost to taxpayers similar to the system already in place at the FDIC for resolving commercial banks and and thrifts.

“In contrast to the current situation, this new regime would not focus on propping up the current firm and its management,” Bair said. “Without a new comprehensive resolution regime, we will be forced to repeat the costly, ad hoc responses of the last year.”

A key question is which institutions should be required to pay into a fund. It wouldn't make sense to include insurance companies but to exclude large hedge funds, for example. And what about the mutual fund industry?

-- Tom Petruno

Photo: Sheila Bair. Credit: Carol T. Powers / Bloomberg News

Financial bailout aid total: $23.7 trillion -- if all goes wrong

In the annals of big bailout numbers, this is the biggest yet: U.S. government agencies could end up having to provide more than $23.7 trillion in assistance if all the programs involved in the financial-system rescue are maxed out, says the federal bailout watchdog.

But the figure, from the special inspector general of the Treasury’s Troubled Asset Relief Program, is an exercise in extrapolation -- and obviously designed to shock.

Neil Barofsky, the inspector general, gives that estimate in testimony he will deliver Tuesday to the House Committee on Oversight and Government Reform.

"Although large in its own right, TARP is only a part of the combined efforts of the federal government to address the financial crisis," Barofsky writes in his latest quarterly report to Congress. "Approximately 50 initiatives or programs have been created by various federal agencies since 2007 to provide potential support totaling more than $23.7 trillion."

The current balance of support provided is about $3 trillion, Barofsky says. About half of that is Federal Reserve lending; the rest includes TARP, Federal Deposit Insurance Corp. assistance and other programs.

To get to the $23.7 trillion of "total potential support," Barofsky calculates that the government’s programs would have to balloon to these amounts: Fed lending, $6.8 trillion; TARP, $3 trillion; FDIC, $2.3 trillion; non-TARP Treasury aid, $4.4 trillion; and various mortgage-aid programs, $7.2 trillion.

"The estimates .. . are designed to suggest the scale and scope of those efforts and not to provide a firm financial statement," Barofsky writes. The numbers aren't meant to suggest what taxpayers could lose, because they don't take into account fees the government collects for the programs or the collateral that agencies take to back up their assistance.

Even so, the Obama administration isn’t amused. From Bloomberg News:

"These estimates of potential exposures do not provide a useful framework for evaluating the potential cost of these programs," Treasury spokesman Andrew Williams said. "This estimate includes programs at their hypothetical maximum size, and it was never likely that the programs would be maxed out at the same time."

Williams said the programs include escalating fee structures designed to make them "increasingly unattractive as financial markets normalize."

If that "normalizing" continues, Barofsky’s estimate will quickly be forgotten. But if the financial system begins to unravel again, his worst-case scenario will be there to haunt the administration, Congress and the rest of us.

-- Tom Petruno

Photo: Neil Barofsky. Credit: Matthew Cavanaugh / European Pressphoto Agency

U.S. raises home refi plan's loan-to-value ceiling to 125%

The Obama administration today eased eligibility rules for its Home Affordable Refinance Program, lifting the maximum loan-to-value ratio to 125% from 105%.

The shift, which regulators had hinted was coming, is aimed at making refinancing available to more homeowners whose homes are worth less than their mortgages.

HARP is open to homeowners whose loans are owned or guaranteed by Fannie Mae or Freddie Mac, the mortgage finance giants now under government control. It covers first mortgages only.

The refi program, launched this year, has gotten off to a slow start, in part because the maximum 105% loan-to-value ratio was too low to include many people whose homes have fallen sharply in value.

The new loan-to-value maximum of 125% means an eligible homeowner with a $375,000 mortgage could refi if his or her house is worth at least $300,000. But the borrower still would have to be able to afford the new loan, and income requirements are an increasing problem as unemployment soars and many workers are forced to take pay cuts.

Treasury Secretary Timothy F. Geithner said the move to raise the loan-to-value limit was "a crucial step in our broader efforts to get America's housing market and economy on the path to recovery."

But refi activity in general remains vexed by the jump in mortgage rates from their generational lows in April. Refi applications to lenders have tumbled since mid-May as rates have surged, according to Mortgage Bankers Assn. data. Despite a down tick in rates in the last two weeks, refi activity hasn’t rebounded.

-- Tom Petruno

Mortgage refi forecast slashed as loan rates rise

Citing the spring jump in long-term interest rates, the Mortgage Bankers Assn. is taking back the wildly optimistic forecast it made in March about home loan refinancings this year.

That will give Federal Reserve policymakers more to chew on as they gather in Washington on Tuesday for their first meeting of the summer.

The mortgage group said it now expected refinancing volumes to reach $1.3 trillion this year, down from the $2 trillion it had predicted just three months ago.

That means, of course, that a large number of homeowners won’t be realizing savings from cheaper mortgages.

MBA Chief Economist Jay Brinkmann said he scaled back the forecast because of the rebound in home loan rates, which have been pushed up by rising long-term Treasury bond yields. The average 30-year mortgage rate as tracked by Freddie Mac was 5.38% last week, up from 4.78% in late April.

Treasury bond yields have jumped amid the government’s record borrowing wave and as some investors sold Treasuries to buy stocks, commodities and other higher-risk investments. Although the Fed has been buying mortgage-backed bonds and Treasury bonds for its own portfolio this year, it hasn’t been able to keep a lid on long-term interest rates.

The Fed could end its meeting Wednesday by announcing that it will boost purchases of mortgage bonds and Treasuries, but many analysts believe that’s unlikely.

The mortgage group said its pared forecast for refinancings also reflected the very slow start to the government’s Home Affordable Refinance Program (HARP) for loans held or guaranteed by  Fannie Mae and Freddie Mac. The plan is aimed at homeowners whose mortgages exceed their property values by as much as 5%.

That still leaves too many underwater homeowners shut out of refinancing, critics of the program say. The chief regulator of Fannie and Freddie suggested last week that to boost participation in the program, the maximum loan-to-value ratio for HARP refinancings might rise as high as 125% from the current 105%.

-- Tom Petruno

Photo: The Federal Reserve building in Washington.

Mortgage rates expected to slide with Fed's new moves

Home loan rates should fall further with the Federal Reserve's latest moves to pull down long-term interest rates -- offering new hope to home buyers and to homeowners looking to refinance.

But how much lower loan rates might drop is a matter of debate on Wall Street. Although the Fed directly controls short-term interest rates, it merely influences long-term rates.

Some experts see mortgage rates tumbling another half-percentage-point in the next few weeks. Others see a smaller decline. Any move lower would be the right direction for the housing market, of course.

The Fed said today it would take two big steps to boost its influence over long-term rates: It will expand its purchases of mortgage-backed bonds to $1.25 trillion from its current commitment of $500 billion, and it also will buy $300 billion of longer-term Treasury securities.

The idea, with both programs, is to try to push up the market value of mortgage bonds and Treasuries, which in turn would pull down interest rates on the securities.

The Fed began buying mortgage bonds at the start of this year, and is credited with helping to keep downward pressure on loan rates. The average 30-year mortgage rate was 4.89% last week, compared with 6.5% last fall, according to the Mortgage Bankers Assn.

Direct purchases of Treasuries would add more firepower to the Fed’s efforts on interest rates, because Treasury bond yields are benchmarks for other long-term rates, such as on mortgages and corporate bonds.

The Fed’s announcement today had the desired effect: The 10-year Treasury note yield plunged to 2.53% from 3% on Tuesday. Treasury yields had been edging higher in recent weeks, but the Fed put the kibosh on that trend.

Ethan Harris, an economist at Barclays Capital in New York, said his firm figures that the Fed’s new commitment to damping long-term rates could bring mortgage rates down about a half-percentage-point in the next few weeks or so. That could mean rates below 4.5%.

Some mortgage brokers were already quoting rates in the 4.5% to 4.75% range today, not including upfront fees, or points, on the loans. . . .

Long-term interest rates dive on Fed plan to buy T-bonds

The Federal Reserve opted for shock treatment today in its continuing efforts to ease the credit crunch: The central bank said it would buy up to $300 billion of longer-term U.S. Treasury securities for its own portfolio over the next six months.

The news instantly sent Treasury yields plummeting: The 10-year T-note yield, a benchmark for mortgage rates, dived to 2.56% by about noon PDT, from 3% on Tuesday.

The 30-year T-bond yield plunged to 3.58% from 3.83% on Tuesday. The two-year T-note dropped to 0.81% from 1.03%.

The Fed’s surprise decision, announced after its regular meeting, also triggered a jump in stock prices. The Dow Jones industrial average, which had been modestly in the red for the session, was up 155 points, or 2.1%, to 7,551 at about noon PDT, the sixth advance in seven sessions.

But the Fed's move has sent the dollar plummeting and gold soaring, on fears that policymakers are pulling out all the stops to boost the economy -- even if that stokes inflation.

The Fed has said in recent months that it was considering buying Treasury bonds, but many bond investors were doubtful the central bank was ready to make that move. The Treasury market was clearly caught by surprise today -- which may be what the Fed was hoping to achieve.

"The Fed has been looking for a new way to make a big headline announcement effect on the markets, and they have found it," said Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi.

By purchasing Treasuries for its own portfolio, the Fed becomes a source of demand for the bonds at a time of record Treasury borrowing to rescue the economy and financial system. Higher demand could, at a minimum, keep a lid on Treasury yields, which in turn could influence other long-term interest rates -- including mortgage rates.

The Fed made another commitment today to pull mortgage rates lower by saying it would buy an additional $750 billion of mortgage-backed securities this year, raising its total purchase commitment for those securities to $1.25 trillion.

A continuing decline in mortgage rates in recent weeks already has fueled a fresh boom in refinancings.

The Mortgage Bankers Assn. said today that its index of refinancing activity nationwide jumped 30% last week from the previous week, to the highest level since mid-January.

As a share of total mortgage activity, refis accounted for 73% of loan applications last week, up from 68% the previous week. Purchase loans accounted for the rest.

The average 30-year loan rate fell to 4.89% in the bankers’ weekly survey, down from 4.96% a week earlier and matching the recent low reached in January. That rate is for 80% loan-to-value mortgages, with an average of 1.23 points, the group said.

Mortgage finance giant Fannie Mae said its refinancing volume soared to $41 billion in February, nearly three times the level of January.

The company, now under U.S. control, said it expected refis to continue to increase under the Obama administration’s mortgage-help program, Making Home Affordable. The plan will allow homeowners to refinance loans held by Fannie Mae or Freddie Mac for a maximum loan-to-value ratio of 105% -- in other words, for 5% more than their home is worth.

-- Tom Petruno

Photo: The Fed's headquarters in Washington. Credit: Karen Bleier / AFP/Getty Images

Plan for Fannie and Freddie to refi loans faces legal issues

The Obama administration last week detailed how it wants to use Fannie Mae and Freddie Mac to refinance millions of mortgages for struggling homeowners who have little or no equity in their houses.

But would it be legal?

From Bloomberg News:

President Barack Obama’s plan to use mortgage-finance companies Fannie Mae and Freddie Mac to refinance as many as five million loans may face legal challenges over whether the administration is overstepping its authority.

The proposal may violate requirements that homeowners put up at least 20% of the appraised value of a home or carry mortgage insurance, said U.S. Rep. Scott Garrett of New Jersey, the ranking Republican on a panel that oversees the companies.

"I don’t see how that stands in face of what the statute says" that governs Fannie and Freddie, Garrett said in an interview. "It certainly seems as though they need to seek a congressional change, a legislative statutory change."

Maybe that's no problem, in any case, with the Democrats controlling the House and Senate.

Fannie and Freddie’s chief regulator, James Lockhart, has said he believes the plan is exempted from the mortgage-insurance rules in the companies’ charters because it would treat the refis as modifications rather than as new loans. . . .

Fannie Mae makes first request for U.S. Treasury cash

Mortgage giant Fannie Mae, now under government control, is planning its first trip to the public trough for money to bolster its balance sheet because of rising loan losses.

The company today estimated it would need between $11 billion and $16 billion of government capital in the aftermath of fourth-quarter losses. The company didn't estimate what its losses would be.

The Treasury in September took control of Fannie and its sibling mortgage firm, Freddie Mac, after the Bush administration decided the companies were in danger of failing. The Treasury agreed to extend up to $100 billion in capital to each, to keep them afloat.

Freddie got $14 billion in aid last fall, and last week said it would need as much as $35 billion more in the near term.

Until now, Fannie hasn't asked for any money. The company warned that the actual amount it draws down from the Treasury "may differ materially from [the] estimate because Fannie Mae is still working through its process of preparing and finalizing" its financial statements.

The two companies own or guarantee a total of $5 trillion in home loans.

-- Tom Petruno

Mood shift on Wall Street: Investors are taking risks again

Sometimes, rising interest rates can be good news. That’s the case with the sudden reversal in yields on U.S. Treasury securities in recent weeks.

Even as Treasury yields have moved back up, yields on other bonds have fallen. And the stock market has continued to rally, lifting key indexes to two-month highs.

All of this suggests that some investors are selling Treasuries to buy other securities. It’s a sign that the fear that had been gripping markets since September -- driving many investors into Treasuries as a haven -- is continuing to ease.

The 10-year Treasury note yield, which fell to a record low of 2.06% on Dec. 30, has rebounded to 2.47%. The 30-year T-bond yield, which was 2.52% on Dec. 18, has jumped back to 3% since then.

On the face of it, this is bad for Uncle Sam and for taxpayers: With Treasury borrowing at record levels to fund the economic and financial bailouts, any increase in yields means a bigger interest bill for the government.

President-elect Barack Obama warned Tuesday that "Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on." Indeed, Treasury yields may be rising in part on concern about the huge supply of bonds coming to market.

But a major goal of the government’s bailout efforts is to restore investors’ willingness to take risks, which should translate into lower borrowing costs for companies, local governments and consumers.

"The whole idea is to get long-end rates down," said Alex Li, interest rate strategist at Credit Suisse in New York.

So far, it’s working:

--- Yields on mortgage-backed bonds issued by Fannie Mae and Freddie Mac sank to record lows Tuesday, which should put more downward pressure on home loan rates. The annualized yield on the benchmark Fannie Mae 30-year bond fell to 3.76% from 4.05% on Monday and 4.73% as recently as Dec. 5.

The Federal Reserve this week made good on its promise to begin buying mortgage bonds for its own portfolio, in an attempt to pull home loan rates lower. The average 30-year mortgage rate was 5.10% last week, according to Freddie Mac, and could fall under 5% this week.

The drop in mortgage bond yields is "extremely important, obviously, and if continued will contribute to an end to the financial and economic crisis," said Tony Crescenzi, bond strategist at Miller Tabak & Co. in New York.

--- In the corporate bond market, the yield on an index of 100 junk bonds tumbled to 13.42% on Tuesday from 14.06% on Monday. The recent peak was 17.70% on Dec. 12. The plunge in yields has driven up bond prices, boosting share values of popular junk bond mutual funds. The T. Rowe Price High Yield fund has surged 9.7% since Dec. 16.

--- In the municipal bond market, the tax-free yield on the Bond Buyer index of 40 long-term bonds has fallen to 5.92% from 6.60% in mid-December.

The question is whether investors are moving back into riskier securities too early. The economic data remain dismal, and the Fed’s report Tuesday of the minutes of its last meeting showed that some policymakers feared a "prolonged contraction" of the economy.

The government on Friday will report December employment numbers. Economists’ consensus forecast is that the nation lost 500,000 more jobs last month.

If fears of a deeper economic crash take hold again, spooked investors may quickly run back to Treasury securities, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, N.J. That could drive yields on the bonds down to levels that would rival those on Japanese government bonds, he said.

The current yield on 10-year Japanese notes is 1.26%, about half the yield of its U.S. counterpart.

Uncle Sam would save a lot borrowing at Japanese yields. But that isn’t the kind of savings taxpayers should be hoping for.

-- Tom Petruno