BizAnalyst Network

By Dawn Kopecki and Jody Shenn

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Federal Home Loan Banks were freed to increase their purchase of mortgage-backed bonds by about $150 billion as part of a government effort to pump money back into a market that slumped as the housing crisis deepened.

Directors of the Federal Housing Finance Board, the banks' regulator, approved the temporary increase today, according to an e-mailed statement. The purchases will be restricted to bonds guaranteed by Fannie Mae and Freddie Mac, the board said.

The approval for Federal Home Loan Banks to increase their purchases comes a week after Fannie Mae and Freddie Mac, the two government-chartered mortgage-finance companies, were cleared to buy at least $200 billion of mortgage securities.

``Every marginal investor helps,'' said Andrew Harding, who helps manage $18 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland. ``You're still in the middle of a long and arduous process, but you're beginning to see some clotting of the hemorrhages.''

About $4.5 trillion of mortgage securities backed by Fannie Mae, Freddie Mac or smaller federal agency Ginnie Mae are outstanding, according to Federal Reserve data.

The 12 banks, know as FHLBs, are cooperatives created by President Herbert Hoover in 1932 to spur mortgage lending. The system's 8,100 owners and customers range from New York-based Citigroup Inc., the largest U.S. bank, to the single-branch Custer Federal Savings & Loan in Broken Bow, Nebraska. Their government ties support top AAA ratings from Standard & Poor's and Moody's Investors Service.

Liquidity Needed

The government increased the limit on the FHLBs' investments to six times capital for two years, up from three times, the statement said. The board said that would increase the banks' spending by ``well in excess'' of $100 billion. Based on the banks' capital of $54 billion, the change may increase the FHLB's purchasing power by about $150 billion.

Yields on 30-year, fixed-rate mortgage bonds guaranteed by Fannie Mae soared to the highest above 10-year U.S. Treasuries in more than two decades earlier this month as some investors balked at buying all but government debt.

``It's an opportunity for the Federal Home Loan Banks to supply more liquidity to the secondary markets,'' said John von Seggern, president of the Council of Federal Home Loan Banks which represents the banks. ``I think that's a good thing and the market needs to get that liquidity as soon as possible.''

The yield gap between the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened by about 5 basis points to 182 basis points today. The spread reached 237 basis points three weeks ago. A basis point is 0.01 percentage point.

Justifying Risk

The spread helps determine the interest rate on new prime home mortgages of $417,000 or less. A basis point is 0.01 percentage points.

The Federal Home Loan Bank of New York isn't likely to rush in to buy mortgage bonds, President Alfred DelliBovi said in a telephone interview today. The bank hasn't been buying many mortgage bonds because they haven't been giving ``a return that justifies the risk,'' he said. Those risks relate to interest- rate moves, rather than credit quality, he said.

``It's no secret that we haven't been able to find enough mortgages to get to three times capital in the last couple of years,'' Dellibovi said,

`A Little Concerned'

The FHLBs have increased their advances to their member banks in the past seven months as concerns about losses on subprime-mortgage securities spread throughout credit markets. The added purchasing power of the FHLBs raised some concerns among analysts.

``I'm a little concerned about everything the federal government's doing because it's taking on more credit risk and bailing out people's risky behavior,'' Paul Miller, a bank analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia, said in a telephone interview. ``The Federal Home Loan Banks have been notoriously bad managers of interest rate risk.''

Seven of the banks, including the Atlanta and Pittsburgh branches, were forced to fix accounting errors for financial contracts used to protect against swings in interest rates.

The Chicago bank entered into a cease-and-desist order in October, promising to revise market risk and hedging policies in light of issues uncovered in an examination, according to its annual report. The bank told its members in its 2007 earnings report to expect losses in the first quarter of 2008 that will ``continue for some period of time.'' Last year's net income fell 49 percent to $98 million.

The Seattle bank operated under a written agreement with its regulator between December 2004 and January 2007, after rising interest rates caused losses.

Fannie, Freddie

The Bush administration last week reduced the amount of capital Fannie Mae and Freddie Mac must set aside as a cushion against losses, allowing them to increase their purchases of mortgages. Combined with a lifting of portfolio caps on March 1 and the companies' existing capabilities, this should allow Fannie Mae and Freddie Mac to buy or guarantee $2 trillion in mortgages this year, according to the Office of Federal Housing Enterprise Oversight.

Fannie Mae and Freddie Mac jumped more than 50 percent in New York Stock Exchange trading last week after the government loosened the capital requirements. Fannie Mae fell $3.14, or 9.2 percent, to $31.16 today and Freddie Mac dropped $1.97, or 6.1 percent, to $30.61.

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