The fate of the zombies? Who else but Fannie Mae & Freddie Mac. What will be the future of housing finance?

The fate of Fannie and Freddie has been put on the back burner while Congress is busy with the passage of the financial overhaul bill since last year. However, the Obama administration has convened a housing summit this week to discuss precisely the fate of both behemoths. Both agencies have cost taxpayers $148 billion in bailouts so far, with no end in sight. They are also backstopped (unlimited) by the government until 2012.

What is certain about these agencies is that there are no easy solutions to deal with them, which certainly will cause heated debates between the government, bankers, Congress, and last but not least U.S. taxpayers. The first salvo was fired by Geithner, who said "we will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support." Furthermore, he said "we will not support a return to the system where private gains are subsidized by taxpayer losses." To me, that is the crux of the whole mess concerning these 2 agencies.

Available solutions range from full nationalization at one extreme to privatization with no government support at the other, with alternatives in between. Government guarantees may need to be provided to cover the risk of losses and structured to minimize taxpayer losses. The government would have to decide how to structure such guarantees, determine which loans would qualify for insurance, what the underwriting standards should be and how private mortgage insurance might be used. Full privatization at this point is not feasible because the agencies and FHA guarantee more than 90 percent of all mortgage loans in the country. Without their guarantee, mortgage rates will increase and cause housing demand to sap which in turn depresses home values further.

Bill Gross from Pimco argued for "full nationalization" of the mortgage finance system. He suggested that private financing is unrealistic and impractical. This is at odds with government officials who have urged for a smaller footprint in the housing market. Furthermore, Geithner reiterated the need to begin the process of weaning the markets away from government programs and make room for the private sector to get back into the business of providing mortgages. The need to keep mortgage rates reasonably priced is also important for mortgage borrowers.

The government has targeted to overhaul housing finance by January 2011. However, the voices that called for full government support will only hamper the progress to wean both Fannie and Freddie from further taxpayer bailouts. Solutions will be forthcoming from both sides, but I think a solution with structured government guarantee and private capital will probably be the way to go. A healthy market with competition would be the best way to encourage more private capital to provide mortgage solutions. At stake is the more than $10 trillion US housing market.

The new year euphoria is still on -- but Pimco has fired the first warning salvo

Everyone is looking forward to a roaring first quarter of 2010, but a few days ago, Bill Gross of Pimco has fired the first warning salvo on US and UK debts. The markets barely registered the news as everyone is focusing on how great the first quarter results would be.

Pimco is reducing the holdings of both US and UK because their governments increased borrowings to record levels. Furthermore, Pimco is cautious on corporate bonds and mortgage-backed securities. As the economy recovers, the inflation expectations are going to be leaning on the high side. As a result, the Fed would be under the gun to perform the appropriate action, i.e. increase Fed rates. But in reality, the Fed is not inclined to do so because unemployment is still stuck in a rut. However, long-term 10-year Treasury yields have already increased to approach 4%. Outstanding U.S. public debt has climbed 58 percent to $7.175 trillion as of November from $4.537 trillion in December 2007 as the government has borrowed to fund two stimulus programs and fund record budget deficits. The U.S. budget deficit reached $1.4 trillion for fiscal 2009.

According to Bill, investors will face lower than average returns coupled with heightened government regulation and scrutiny and slower economic growth.

Pimco's money managers favor sovereign debt, corporate bonds and currencies in emerging markets. Bill also likes Germany, where the government is more fiscally conservative as it pledges to balance its budget by 2016.

This serves as a wake-up call for the US, UK and particularly Japan because 2010 would not be any easier on the government finances as in 2009. Quantitative easing and stimulus measures are only effective up to a point, and should be withdrawn appropriately after.