Bush's Bad Mortgage Medicine

By Liz Moyer (Forbes)

The Bush Administration's plan to rescue the housing market and keep the economy from slipping into recession took flak yesterday for freezing interest rate hikes for a mere fraction of subprime, adjustable-rate borrowers. But there's a bigger risk: It could deepen and lengthen the credit crisis.

According to analysis by Barclays Capital, the "freezer-teaser" plan applies to just 240,000 subprime loans. The Mortgage Bankers Association reports the number of subprime adjustable rate mortgages at 2.9 million.

It also won't help the 16% of subprime borrowers who are already delinquent or in default, and it won't help millions of other homeowners who either will be deemed able to pay the higher rates when they adjust, starting in January, or who have the unhappy circumstance of having a house worth less than their mortgage or a loan that has already reset to the higher rates.

President Bush, along with Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson, outlined other proposals Thursday that are meant to help the 2 million borrowers facing sharply rising rates on their adjustable-rate mortgages beginning next month. The plan includes refinancing some of the borrowers into private, fixed-rate mortgages, or putting them into Federal Housing Administration loans.

The loan modification, or rate freeze, would apply to a limited subset of subprime borrowers who meet a series of criteria, not least of which is that they must have paid their loans on time. Also, the freeze applies to loans taken between January 2005 and July 2007, excluding other adjustable loans that have already reset to higher rates.

The expected backlash to the plan started immediately after the Administration announced it. Housing advocates said it leaves millions of struggling borrowers at risk of foreclosure. Others decried it as a shameful bailout of irresponsible lenders and borrowers.

"President Bush's plan may make good politics, but it is terrible economics," said Edward Ketz, an accounting professor at Penn State University. "It punishes those who have acted prudently and rewards bad decisions by homeowners who bought what they could not afford. It gives incentives for future homebuyers to act rashly, because they may believe Washington will rescue them from error and greed."

Perhaps more significantly, Ketz and others warn the plan could further choke off the credit markets and result in higher mortgage rates in the long run.

Declining values in mortgage securities have plagued banks and investors since the summer, with banks writing off some $70 billion in mortgage and credit securities in the last three months. Modifying the terms of the underlying mortgages for some of these securities will mean payments even lower than the amounts investors had counted on when they bought the mortgage pools in the first place.

Mortgage servicers either originate their own loans or buy loan-servicing rights to them. The loans are sold to banks, which then chop them up and repackage them in securities, complete with ratings and tranches to appeal to different types of investors. These investors buy the securities expecting certain performance characteristics, including payment flows from the borrowers of the underlying loans.

If an investor can't count on the terms of a mortgage security at the time he buys it, he has less incentive to continue investing in them in the future. That would reduce demand for mortgage paper, in addition to embedding a risk premium in the rate for those investors still willing to take the gamble.

Investor demand for mortgage-backed securities--and banks' eagerness to buy loans, package and sell them to this hungry crowd--helped create the incredible run-up in the mortgage market over the last three years. Paulson's plan does not protect the investors of these securities--increasingly, as it turns out, public pensions and other public funds.

In a report Thursday, Standard & Poor's said freezing rates without assuring against further defaults "would have a negative impact on the ratings of certain U.S. first-lien subprime" mortgage securities. "Declining investor participation means reduced capital and liquidity, which may affect homeownership and borrowing opportunities," the company said.

In other words, this plan could make the whole situation worse, not better.

Secretary Paulson has been eager to show he is trying to alleviate the crisis, though many say he and the rest of the Administration have been slow to make a move. Mortgage payment delinquencies hit a 20-year high in the third quarter, according to the Mortgage Bankers Association, as borrowers were unable to refinance or sell their homes to get out of a credit pinch. The percentage of loans with payments more than 30 days late, including prime mortgages, rose to 5.59%, its highest level since 1986.

"Politicians want to look like they are doing something while not doing something," says Joseph Mason, a professor at Drexel University who studies banking regulation and capital markets. "This plan fits that perfectly."

What it also does is pass the problem on to the next president, who will be elected next fall, well before the freeze on those mortgages lifts--and possibly before the markets turn around. Despite a strong showing in many financial stocks Thursday after the plan was announced, analysts forecast slower growth for banks as they come to terms with rising credit costs and a slowdown in their bond divisions.

University of Maryland business professor Peter Morici puts is this way: "The Treasury seems obsessed with what investment bankers do best in a pinch--short-term workouts that punt difficulties into the high grass."

Subprime Rate Five-Year Fix Agreed by U.S. Regulators

By Alison Vekshin (Bloomberg)

Federal regulators and U.S. lenders agreed to freeze interest rates on subprime mortgages for five years to stem rising foreclosures, said a person familiar with the measure.

President George W. Bush will announce the accord tomorrow, which was negotiated by officials including Treasury Secretary Henry Paulson. Paulson will hold a press conference tomorrow at 1:45 p.m. in Washington to discuss the plan, Treasury said in a statement.

``Fixing the reset period is an important action, and it's good that everyone now seems to be pushing in the same direction,'' said Michael Barr, a professor at the University of Michigan Law School and a former aide to Robert Rubin, who was President Bill Clinton's Treasury secretary from 1995 to 1999. ``Now the question is what additional steps are required to keep people in their homes and avoid foreclosures.''

Paulson finalized the deal as the housing recession entered a third year, threatening the economic expansion.

More than 30 percent of borrowers with subprime adjustable- rate mortgages are behind on their payments before their loans reset higher and 775,000 homes with $143 billion of mortgage debt will go into foreclosure over the next two years, according to estimates from analysts at Credit Suisse Group.

Dates, Scores

The freeze may apply to mortgages issued between January 2005 and July 2007 that are currently scheduled to reset between January 2008 and July 2010, said a person who has seen a draft proposal. Borrowers whose credit scores are below 660 out of a possible 850 and haven't risen by 10 percent since the loan was issued will be given priority.

Those with scores above 660 will be more closely scrutinized to determine whether they are eligible or must continue making payments under existing terms, said the person.

Officials and company executives spent much of the past week negotiating over how long to extend starter rates on subprime mortgages, which are usually given to people with poor or incomplete credit histories.

Most U.S. banks use FICO credit scores, a product of Minneapolis-based Fair Isaac Corp., to judge a borrower's ability to repay loans. Scores are correlated to interest rates banks are willing to charge.

Republican Briefing

Paulson briefed House Republicans today on the plan in a meeting in Washington.

Representative Adam Putnam of Florida, the chairman of the House Republican Conference, said yesterday his interest in Paulson's efforts rose since he got calls from Florida officials about a state investment pool for local governments hit by debt downgrades. The state board froze withdrawals Nov. 29 to stem a run on assets. Rising mortgage defaults spurred billions of dollars in losses on securities backed by the loans.

``Florida in general increases my thinking that we need to look at the reasons to help mitigate the subprime meltdown,'' Putnam said.

Other Republicans expressed skepticism today.

``My biggest concern is that there are a lot of Americans who are making their mortgage payments, they are current, and the benefit won't go to them,'' Representative Spencer Bachus, the top Republican on the House Financial Services Committee, told reporters after the meeting with Paulson today.

Democratic Senator Hillary Clinton of New York, a candidate for her party's presidential nomination, reiterated today her support for a five-year freeze. Speaking at New York's Nasdaq stock exchange, she said ``Wall Street helped create the foreclosure crisis, and Wall Street needs to help us solve it.''

Litigation Threat

One challenge will be to craft a deal minimizing lawsuits from investors in bonds backed by the mortgages being rewritten, analysts said. The longer that lower rates are extended, the more risk posed to the bonds' values. Republican Representative Mike Castle of Delaware has proposed legislation offering a ``safe harbor from legal liability'' to mortgage servicers.

``Within the contracts, there is room for the servicers to work with borrowers to minimize the loss for the investor,'' said Wayne Abernathy, executive director of financial-institutions policy at the American Bankers Association in Washington and a former Treasury assistant secretary.

About 100,000 subprime loans will jump from their discounted initial rates every month for the next two years, UBS AG estimates. American home foreclosures almost doubled in October from a year earlier as subprime borrowers failed to make higher payments on adjustable-rate mortgages, Irvine, California-based RealtyTrac Inc. said on Nov. 29.

Extending Starter Rates

These mortgages usually begin with a rate of 7 percent to 9 percent and then reset to between 11 percent and 13 percent. ``What we are talking about is having these loans modified, so they continue for a longer period of time at the starter rate,'' John Reich, director of the Office of Thrift Supervision, said in an interview in Washington Dec. 3.

Treasury spokeswoman Jennifer Zuccarelli declined to comment on specifics of the proposal.

Paulson and Fed Chairman Ben S. Bernanke are concerned that falling home values will choke consumer spending, which has driven economic growth since the last recession ended in 2001. By heading off further deterioration in the $11.5 trillion mortgage market, officials are also aiming to stem losses on securities backed by subprime loans.

The Bush administration's efforts to forge an agreement have become more urgent as the economy falters after a third-quarter spurt. Growth may cool to an annual rate of less than 1 percent in October to December, economists say, following an expansion of 4.9 percent in the prior three months.

No `Silver Bullet'

``The number of subprime-mortgage resets is going to increase dramatically next year, and we need to make sure the capacity is there to handle it,'' Paulson said in a speech at a Dec. 3 housing conference in Washington. While no ``silver bullet,'' rewriting a set of subprime loans would ``clearly'' ease the risks from the housing slump, he said in an interview.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., has been working with Paulson and said she favors extending introductory rates for between five and seven years.

Fannie Mae Chief Executive Officer Daniel Mudd told reporters at the OTS event that a cap of at least two or three years ``seems to make sense.''

Paulson said in his speech that the government is focused on helping subprime borrowers who can afford the introductory mortgage rate but not the adjusted one. The plan ``does not, and will not, include spending taxpayer money on funding or subsidies for industry participants or homeowners,'' he said.

AT&T to leave pay phone business (Bloomberg News, Reuters, The Associated Press)

SAN ANTONIO, Texas: AT&T said Monday that it would leave the rapidly shrinking pay phone business by the end of next year, getting out before it becomes unprofitable. AT&T will sell 65,000 pay phones, located in prisons and in public places, within its original 13-state area before the end of 2008, a spokesman, Michael Coe, said. AT&T decided to leave pay phones, a tiny segment for the telecommunications company that has 67.3 million wireless subscribers, before they reach the point of being unprofitable, he said. Company executives said they expected the pay phones to be purchased by independent operators.

"This business has been shrinking rapidly," said Coe, who said AT&T had already begun phasing out its operations by not renewing contracts as they expired. "We've known for a while that we would exit." The pool of U.S. pay phones has decreased in the past decade to one million from 2.6 million, the company said. BellSouth, which AT&T acquired at the end of 2006, already has left the business, as has Qwest Communications International.

The first pay phone, which had an attendant who took callers' money, was installed in 1878, and the first coin-operated phone was placed in a bank in Hartford, Connecticut in 1889. Both devices were operated by companies that were predecessors to AT&T, Coe said The number of wireless subscribers has quadrupled in the past decade and about 80 percent of people in the United States have mobile phones, according to CTIA-The Wireless Association, an industry group. AT&T itself added two million mobile subscribers in the third quarter to reach its current total and help make it the largest American phone company. Coe would not disclose how much AT&T expected to save by dropping pay phone operations, saying only that it represented "a very small part of our overall business."

Verizon Communications, the second-biggest U.S. carrier, still operates pay phones, a spokesman for the company, Robert Varettoni, said. The use of pay phones has been declining in much of the developed world because of the popularity of mobile phones. But some complain that ending pay phone service restricts access of low-income, low-credit consumers to communications.

Bernanke Adds to Rate-Cut Hints

By SUDEEP REDDY (Wall Street Journal)

Federal Reserve Chairman Ben Bernanke, in a signal he is open to cutting interest rates, said the latest bout of turbulence in financial markets may put more strain on the economy. The housing downturn and related mortgage turmoil are adding "greater than usual" uncertainty to the economic outlook, Mr. Bernanke said, in prepared remarks last night in Charlotte, N.C. "These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors."

Fed officials are increasingly paving the way for a rate cut at their Dec. 11 meeting, barring a significant improvement in either market conditions or economic data. To determine their next move, Mr. Bernanke said Fed policy makers would be closely watching a stream of data arriving in the next two weeks -- including readings due out today on personal income and spending and next week's report on the November job market.

"I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some head winds for the consumer in the months ahead," he said. He also reiterated worries that surging costs of food and energy, along with the weak dollar, could raise the public's inflation expectations and erode price stability. Inflation has remained relatively tame in recent months.

Mr. Bernanke's comments echoed remarks by Fed Vice Chairman Donald Kohn on Wednesday that led markets to conclude the Fed would cut interest rates to offset the risks posed by mortgage-related troubles in the credit market. Investors expect the Fed to cut interest rates by at least a quarter percentage point next month from the current 4.5%, and markets are putting the odds of a half-point cut at 50%. Further easing, especially putting a larger cut on the table, could draw opposition from some policy makers. But Fed officials are grappling with an economy struggling under the weight of tighter lending standards and a depressed housing market.

The Commerce Department said yesterday that new-home sales rose 1.7% in October, but the median price of a new home in October was down 13% from a year earlier, to $217,800. Many economists expect economic growth this quarter to come in below 1%, and some are forecasting a slight contraction. Underscoring the spreading weakness, new claims for unemployment insurance last week rose a seasonally adjusted 23,000, to 352,000 -- their highest level since February -- an indication the labor market is beginning to deteriorate. The four-week average of new claims, a more accurate gauge of the underlying trend, increased 5,750, to 335,250, the highest level since March, the Labor Department said.

Yesterday, the government raised its estimate of the economy's growth pace in the third quarter to an annualized 4.9%, a full percentage point above its previous estimate. But that did nothing to change assessments that growth is grinding nearly to a halt this quarter. The revision of the third quarter's gross-domestic-product growth, which was widely anticipated, reflects upward revisions in the tally of exports and inventories, which could portend production cutbacks. The third-quarter economy was "helped by the fact that the credit crunch was barely under way when the majority of this growth data was collected," said economist Rob Carnell of ING Bank. He said more-timely data "indicate a much broader weakening of the economy and also few signs of inflation outside food and energy."

The Commerce Department also reported a decline in a measure of corporate profits in the third quarter, with cash flow falling for the third quarter in a row. The Fed's favored inflation gauge -- the price index for personal-consumption expenditures other than food and energy -- was up an unrevised 1.8% in the third quarter from last year, higher than the second quarter's 1.4%, but within the comfort zone of some Fed officials.

Fannie, Freddie loan limits kept at current level

by Neil Adler Contributor (Baltimore Business Journal)

The regulator for Fannie Mae and Freddie Mac said Tuesday that the maximum conforming loan limit in 2008 for single-family mortgages purchased by the two mortgage-finance companies will remain at this year's level of $417,000 for one-unit properties in most of the U.S.

Higher limits apply to Alaska, Hawaii, Guam and the U.S. Virgin Islands, as well as to properties with more than one unit.

The conforming loan limit determines the maximum size of a mortgage that Washington, D.C.-based Fannie Mae or McLean, Va.-based Freddie Mac may buy or guarantee. Both companies purchase residential mortgages and also package loans into mortgage-backed securities for sale to other investors.

By law the maximum conforming loan limit is based on the October-to-October change in the average house price in the Monthly Interest Rate Survey of the Federal Housing Finance Board. This board reported the decline in the average price was $10,685, or 3.49 percent, from $306,258 in October 2006 to $295,573 in October 2007. The combined two-year decline is now 3.65 percent.

"While the house price survey data used in determining the conforming loan limit show a decline over the past year, as previously announced and consistent with the proposed new conforming loan limit guidance, the level will remain at $417,000 for the third straight year," James Lockhart, director of the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), said in a statement.

U.S. lawmakers have sought to increase the conforming loan limit for the two mortgage finance giants, with the hope that Fannie Mae and Freddie Mac could provide some liquidity to the mortgage market, which continues to struggle from the fallout in the subprime sector.

Citigroup to sell $7.5 billion stake to Abu Dhabi

By Dan Wilchins and James Cordahi

NEW YORK/DUBAI (Reuters) - Citigroup Inc is selling up to 4.9 percent of itself for $7.5 billion to the Gulf Arab emirate of Abu Dhabi, giving the largest U.S. bank fresh capital as it wrestles with the subprime mortgage crisis and the resignation of its chief executive.

The capital injection will shore up Citi's balance sheet, which has been hurt by some $6.8 billion of writedowns and losses in the third quarter, and the potential for another $11 billion in the fourth quarter. Citi is paying a high price for the capital injection by selling mandatory convertible securities to Abu Dhabi which pay a fixed coupon of 11 percent. That is above the average yield on U.S. junk bonds, which is 9.4 percent according to Merrill Lynch data. Analysts at Royal Bank of Scotland said in a note that Citigroup was paying a "high price," but that the convertible notes would help boost the bank's core capital.

The sale to the $650 billion Abu Dhabi Investment Authority, the world's largest sovereign wealth fund, may also signal the freefall in U.S financial stocks is close to ending, analysts said. "Citi is big, it's widely followed, and when people see confidence in it, it should mean something," said Bo Brownstein, an analyst covering financial stocks at Cambiar Investors in Denver, Colorado. The dollar rose against the yen on the news, and Japanese bank stocks also rallied. In Tokyo trading, Citi shares fell 4.2 percent for the day, but had been trading even lower before news of the Abu Dhabi deal.

Family ruled Abu Dhabi -- whose citizens number no more than 400,000 -- will be Citi's largest shareholder. The investment reflects the increasing financial might of oil-producing countries, which have benefited from a five-fold increase in the price of crude oil during the last six years.

Gulf investors have announced more than $70 billion of foreign acquisitions this year, more than in the previous two years combined.

Dubai International Capital, a private equity firm owned by the ruler of Dubai, said on Monday it made a "substantial investment" in Sony Corp (Tokyo:6758.T - News), while a separate Abu Dhabi entity earlier this month bought a $622 million stake in U.S.-based chip maker Advanced Micro Devices Inc.

Gulf investors such as the state-owned Investment Corporation of Dubai have expressed interest in taking advantage of plummeting U.S. financial stock prices to buy. Shares of Citigroup have plunged 42.5 percent during the last five months. Merrill Lynch & Co, which wrote down $8.4 billion of assets in the third quarter, is down 40.6 percent during the same period. Abu Dhabi Investment Authority manages the surplus revenues of the government of Abu Dhabi, the world's sixth-largest oil exporter. Standard Chartered estimated in September its assets were worth $650 billion. Both Dubai and Abu Dhabi are members of the United Arab Emirates federation. Sir Win Bischoff, Citi's interim chief executive said in a statement on Monday: "This investment, from one of the world's leading and most sophisticated equity investors, provides further capital to allow Citi to pursue attractive opportunities to grow its business."

State-run funds are keen for stakes in global banks, which can benefit from the development of emerging markets, a person familiar with the funds said. Citi operates in over 100 countries, and has boosted its investments in emerging markets over the last 12 months.

MORE THAN $100 BILLION

Acquisitions in general have taken up some $25 billion of Citi capital over the last year, according to CIBC World Markets analyst Meredith Whitney. Combined with writedowns in the third quarter and expected future writedowns, Citi may have to cut its dividend to replenish its capital, Whitney wrote on October 31. She estimated that Citi would need another $30 billion of capital. Citi said on November 4 it does not plan to cut its dividend. On the same day, Citi said it may take $8 billion to $11 billion of additional writedowns in the fourth quarter, and that its chief executive Charles Prince was resigning. Citi is also taking early steps to cut staff and reduce costs, according to press reports. Citi said earlier this year it was cutting about 5 percent of its staff, or 17,000 jobs.

On Monday, Citi shares closed at $29.80 on the New York Stock Exchange, falling below $30 for the first time in more than five years amid mounting concerns of further losses and writedowns. Citi's market value has fallen by more than $100 billion this year. U.S. Senator Charles Schumer, who opposed Dubai Ports World's plan to purchase assets at six U.S. ports and raised questions about Borse Dubai's plans to swap stakes with Nasdaq, said the Citi transaction will bolster the bank's competitiveness and "help preserve New York's status as the world's financial center."

After conversion, Abu Dhabi's stake would be larger than the current holding of Saudi Prince Alwaleed bin Talal, who is one of Citi's largest shareholders. Prince Alwaleed acquired his Citi stake in 1991 when the bank struggled with Latin American loan losses and the U.S. real estate market collapse, and his shares in the banks were worth some $6 billion earlier this month. Last month, Bear Stearns Cos Inc and China's CITIC Securities Co agreed to swap stakes and form a broad alliance. Bear Stearns had also been battered by the subprime mortgage crisis, and many investors had hoped its tie-up with a foreign bank would include a cash infusion.

JUST A REGULAR SHAREHOLDER

The Abu Dhabi Investment Authority will have no special rights of ownership or control over Citi and no role in the management or governance of the bank, including no right to name board members. The investment group is buying mandatory convertible securities that can be converted into Citi stock in 2010 and 2011 at prices ranging from $31.83 to $37.24 per share. The number of shares it receives will adjust based on Citi's share price, with a higher share price giving the investor fewer shares. The securities will also pay a fixed coupon of 11 percent per year, payable quarterly. That may seem steep, but after accounting for the fact that 60 percent of that coupon is tax-deductible, the coupon rate is similar to the dividend rate on Citi's shares, a person familiar with the matter said. The investment is expected to close within the next few days, Citi said. Saeed al-Hajeri, executive director the Abu Dhabi Investment Authority, could not immediately be reached for comment.

Fannie and Freddie pullback would devastate economy

By Patrick Rucker - Analysis

WASHINGTON (Reuters) - If anyone thinks the current U.S. housing downturn is bad now, things would get far worse if Fannie Mae or Freddie Mac to suddenly stop buying mortgages, a move that would drive up the costs of home loans and devastate the economy. Fannie Mae and Freddie Mac, the nation's two largest sources of mortgage finance respectively, recently reported combined losses of $3.5 billion. Borrowing costs have skyrocketed and investors have erased billions of dollars in each company's equity market capitalizations. Few think the two companies are likely to pull out of the housing market, even temporarily. However, if the stream of home loan failures were to force the companies to suspend new mortgage investments, the market for mortgage bonds would "freeze up," said Tom Sowanick, chief investment officer of Clearbrook Financial LLC in Princeton, New Jersey.

Already, the housing slowdown has subtracted about 1 percentage point from growth in inflation-adjusted gross domestic product so far this year. Taking Fannie Mae and Freddie Mac out of the home loan business would flatten the already listless real estate market, said Robert MacIntosh, chief economist with Eaton Vance Management in Boston. "It would be devastating," he said. "Why would anyone consider buying a house if the two biggest ultimate credit givers and lenders to the housing industry shut down?"

While Fannie Mae and Freddie Mac do not offer credit directly to borrowers, they do buy home loans and repackage them as investments for Wall Street. The companies also buy mortgages to hold in their money-making investment portfolios. Both steps make the market more liquid by taking long-term investments off a lender's books.

Fannie Mae and Freddie Mac own or guarantee a combined $4.8 trillion of U.S. home mortgage loans of more than 40 percent of the total outstanding. That size, in part, explains why Fannie Mae and Freddie Mac are likely to survive the current housing and credit downturns. Another factor is that these companies were relatively cautious during the recent housing boom and did not make big bets on the risky subprime market, which involves borrowers with damaged credit. While Fannie Mae and Freddie Mac expect the number of failing mortgages on their books to double, that still represents less than 0.12 percent of the home loans they guarantee for investors. And maybe most importantly, the companies benefit from their status as government-sponsored enterprises, which many investors treat as a guarantee of a federal bailout if either were to stumble.

Fannie and Freddie also have credit lines to the Treasury Department, which have never been tapped, fostering the perception that they are wards of Uncle Sam. The companies are simply so large and risk-averse that they set a standard for the industry that would be hard to replicate if they were to step away from the market, said Jim Vogel, who tracks the companies for FTN Financial in Memphis, Tennessee. "They are like the U.S. Treasury of the mortgage market," said Jim Vogel, who tracks the companies for FTN Financial in Memphis, Tennessee. "The general mortgage-backed security trades on the spread set in the Fannie and Freddie market."

If Fannie Mae and Freddie Mac were to step away from the mortgage investments, it would not only send the mortgage market into a devastating tailspin, but the broader market as well, which is why many observers say it simply will not happen.

"It would aggravate the liquidity crunch. The psychological impact would be huge. The GSEs have been seen as the backstop buyers for all types of mortgage paper," said Wan-Chong Kung, senior portfolio manager at FAF Advisors at Minneapolis. But most agree with MacIntosh when he says: "It would be devastating -- but I don't think that would happen at all, there is no chance of that." And any move away from the mortgage market would destroy their stock prices -- both of which are already trading at around 10-year lows. "Fannie Mae and Freddie stocks would collapse because there would be no growth prospects," for the companies, Sowanick added.

Dan Fuss, vice-chairman of Loomis Sayles, which manages $100 billion in fixed-income assets, said he doesn't believe Fannie and Freddie will stop buying mortgages. And he points out: "You need a public policy response to the housing crisis."