Investors Dump Securities From Fannie, Freddie

Mortgage Sector Strongholds Falter

As the business of making and trading mortgages has deteriorated over the past year, one of the few market segments still functioning smoothly was that managed by Fannie Mae and Freddie Mac, two companies chartered by the government to keep mortgage money flowing.

Now, even their part of the market appears to be weakening.

The prices of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac have plunged lately as supply has grown faster than demand. That indicates that their ability to prop up the lending system has declined.

"The implications are quite onerous because this was the one market that was functioning, and moreover, this is the market that the administration was counting on to maintain its liquidity so that it could help all these troubled homeowners," said Douglas A. Dachille, chief executive of First Principles Capital Management.

"If this continues, this is going to be very bad for home prices," Dachille said.

Fannie Mae, based in the District, and McLean-based Freddie Mac package mortgages into securities for sale to investors, guaranteeing to pay the principal and interest if the borrowers default. That enables lenders to move mortgages off their books and replenish the funds they use to issue new mortgages.

Historically, guarantees from Fannie Mae and Freddie Mac have been regarded as nearly as solid as those of the U.S. government.

The perceived risk of Fannie Mae and Freddie Mac mortgage securities is reflected in the spread between the interest rates on those instruments and the rates on U.S. Treasury securities with comparable terms. Widening spreads -- in other words, increasingly high rates on Fannie Mae and Freddie Mac securities relative to Treasurys -- indicate that investors' appetite for the firms' securities is declining.

Measured one way, yesterday's spreads for the government-sponsored enterprises were the widest since 1986, at 2.48 percentage points, said Kevin Cavin, a mortgage strategist at FTN Financial Capital Markets.

Troubled investment funds have been dumping Fannie Mae and Freddie Mac securities to cover losses on less-marketable mortgage investments, Cavin said. Yesterday's spread was the result of massive selling "by leveraged investors, namely the hedge fund community, who have had to sell their most liquid and highest quality assets . . . to meet margin calls from their lenders because their weakest quality assets . . . have seen extremely sharp declines in market value and there are few if any buyers of those securities," Cavin added by e-mail.

Meanwhile, brokers that allowed investment funds to buy Fannie Mae and Freddie Mac securities with borrowed money are requiring them to put up additional collateral, Dachille said.

The widening spreads "signify there's volatility in the market for our securities," said Freddie Mac spokesman Michael Cosgrove. Nonetheless, "it's been a very liquid, very orderly market," Cosgrove said.