Furgeson Wellman by Brad Houle, CFA Senior Vice President

Ben Bernanke’s tenure as Fed Chairman is coming to an end this year. He became Fed Chairman in 2006 and led the organization through the financial crisis. Prior to his tenure as Fed Chairman, he was an economics professor at Princeton University. One of his primary areas of interest was the Great Depression and that perspective shaped the Federal Reserve’s response to the crisis.

Janet Yellen has been nominated as the next chair of the Federal Reserve Open Market Committee. She is expected to be confirmed and would start to serve her term in early 2014. The financial markets are in favor of a Yellen Fed in that her viewpoint is thought to be similar to the outgoing Ben Bernanke. She is characterized as being “dovish” which means that she is in favor continuing zero interest rate policy and quantitative easing for an extended period of time until unemployment is reduced to a more acceptable level. Financial markets crave as much certainty and continuity as possible and the Yellen Fed fits the bill. She was tasked by the outgoing Chair Bernanke to facilitate a more open and transparent Fed. It is expected that Yellen will use this platform to steer expectations of market participants.

Countless articles and endless analysis of the Yellen Federal Reserve in the financial press have debated the minutia and theorized what a Yellen Fed will be like. At Ferguson Wellman, we have a unique perspective on the Yellen Federal Reserve. Jim Rudd, CEO of Ferguson Wellman, had the opportunity to serve as the Chair of the Portland Fed for several years under Janet Yellen who was then President of the 12^th District of the Federal Reserve of San Francisco. Having witnessed her management skill first hand, Jim commented that she embraces the culture of the Fed and has the ability to manage the process of setting monetary policy. He also indicated she was on the front line of the real estate crisis in the Fed 12^th district during the Great Recession and that had a lasting impact on her and how she views the fragility of the recovery.

Takeaway This Week

There were not a lot of surprises from the Fed minutes released on Wednesday. The only material change was language surrounding an acknowledgement of a slowing in the housing recovery

Disclosures

Furgeson Wellman by Brad Houle, CFA Senior Vice President

There was plenty of controversy this week in Washington with the government shutdown and the looming deadline for raising the debt ceiling. However, there was another controversial situation at play that has been pushed further off into the future. Fannie Mae and Freddie Mac are government sponsored enterprises that guarantee and securitize mortgages for U.S. homeowners. These entities perform an important function in the U.S. economy by guaranteeing the payment of principal and interest and securitizing or “packaging” mortgages for sale to institutional investors. Americans will recall that Fannie Mae and Freddie Mac both got into financial distress during the financial crisis due to excessive leverage and lax underwriting standards. As a result, the U.S. government had to step in and take Fannie Mae and Freddie Mac into conservatorship in September of 2008.

Fannie Mae and Freddie Mac have now been stabilized and have actually been returning robust profits. Specifically, since 2011 they have paid back $131 billion in dividends to the U.S. Treasury of the $187 billion bailout they received. Fannie Mae and Freddie Mac have long been viewed as an uneasy mixture between a private enterprise and a public entity. Recently there have been legislative attempts to eliminate Fannie Mae and Freddie Mac as we know them. The current administration believes that private capital should play a larger role in the mortgage market.

Investors in mortgage-backed securities issued by Fannie Mae and Freddie Mac rely on the implied government credit guarantee. If that is removed, the cost of mortgages is estimated to rise by one to two percentage points. As such, investors will demand a higher return to own mortgage-backed bonds with a greater risk that interest and principal will not be repaid. In a housing market that is still recovering from the financial crisis, an increase in mortgage rates due to this change would hamper the pace of economic growth.

What will actually happen is still very much up in the air. One thing that is virtually certain is the payoff of Freddie and Fannie debt obligations. To back off the current guarantee would throw financial markets and especially the mortgage-backed securities market into turmoil.

Takeaways

The evolution of mortgage financing and the eventual fate of Fannie Mae and Freddie Mac is a political controversy that does not have a simple private market solution

Disclosures

What to Expect When You Are Expecting a New Fed Chair

Fannie and Freddie's Fate