Fannie and Freddie and the subprime mortgage fiasco: how much exposure?

Investors should consider the effects of the deterioration of the mortgage market on Fannie and Freddie, the two biggest buyers of risky mortgage-backed securities. It is not clear what their total exposure might be. Freddie reports that it owns $134 billion and Fannie reports $56 billion of "subprime" mortgages.

However, both also hold pools of mortgage-backed securities not issued or guaranteed by them, as a result of "private placement." There is controversy among experts in this market segment about how much of the private placement portfolio should be classified as subprime or as "relatively risky." In general, experts seem to agree that a dominant share of the U.S. market for "private label issues" is attributable to subprime or risky loans.

Probably more important in evaluating the future impact on Fannie and Freddie is what Congress might require of them in the future. During the last two years, political pressure was already building on Fannie and Freddie to curtail the size of their total portfolios of income-generating mortgage-backed securities. Now, in 2007, politicians are beginning to call for "relief" for low-credit families that would enable them to keep their existing homes or buy "affordable housing." It is likely that Fannie and Freddie will be subject to intensifying political pressure to increase lending to low-income borrowers as a share of their total loan portfolios, to help ease the housing market downturn. This would, of course, increase the exposure of Fannie and Freddie to the riskiest segments of the housing market.