Fannie Mae Problems May Boost Home Buying Costs

U.S. home buyers may see a slight rise in mortgage rates if housing finance company Fannie Mae (FNM), which is mired in an accounting scandal, slows purchases of bonds backed by home loans in response to new rules imposed regulators.

This purchase of securities that pool monthly mortgage payments has been a key ingredient to Fannie Mae's growth. But, an agreement with its regulator requiring the company to set aside more cash may curtail these purchases.

The new rules come a week after the Office of Federal Housing Enterprise Oversight (search) (OFHEO) accused Fannie Mae of widespread problems with accounting and internal controls.

On Monday, OFHEO said Fannie Mae had agreed to keep billions of dollars more in cash on hand while it corrects the accounting problems. As part of Monday's deal with OFHEO, Fannie Mae has to maintain 30 percent more capital on its balance sheets than current rules mandate.

In addition to cutting its purchases of mortgage bonds, Fannie Mae could sell stock and slash dividends paid out to shareholders, according to Bert Ely, of Ely & Co., an independent bank consulting firm. But, "if they pass on costs to home buyers that may add to their political woes which, have escalated dramatically in the last week."

Mortgage banks typically bundle home loans into bonds, known as mortgage-backed securities, for resale with the help of Fannie Mae and its smaller counterpart, Freddie Mac (FRE).

Both of these congressionally chartered companies sell guarantees insuring timely payment of monthly mortgage principal and interest payments. These guarantees allow mortgage banks to sell bonds pooling mortgages to investors like insurance companies and mutual funds.

Fannie and Freddie, which are able to raise money cheaply because of an implied link to the U.S. government, have regularly bought mortgage bonds.

This demand has helped narrow mortgage bond spreads, the premium over U.S. Treasury yields (search) paid out to investors.

But "if Fannie Mae stops buying MBS or significantly slows purchases, then MBS spreads will widen slightly," said Art Frank, head of mortgage backed bond research at Nomura Securities International Inc. "It will slightly increase by a few basis points the rate to a borrower," he said.

A basis point is the equivalent of 0.01 percentage points.

A widening in mortgage bond spreads, then, will mean it costs more for lenders to sell off their mortgage loans. This, in turn, pushes up rates offered to borrowers slightly.

At the same time, a drop in mortgage bond purchases could affect Fannie Mae shareholders because the government agency will make less money by buying fewer mortgage bonds.

Some market observers said Fannie Mae could bolster the capital it needs to set aside by increasing fees charged to guarantee home loans.

"They'll lose market share if they raise guarantee fees significantly," Frank said. "But it is possible a slight increase for guarantee fees may be something they can consider."

"It might be politically dangerous to raise the guarantee fees. They (Fannie Mae) might be perceived as passing the expense on to the backs of consumers and Congress may not like that very much," said David Beadle of BestInfo Inc., a mortgage consultant.