In a touchy year for the Federal Reserve, the central bank still found one big present under its tree: the Treasury Christmas eve decision to provide an unlimited backstop for Fannie Mae and Freddie Mac. GSEs need all the help they can get, so the gift was also more than good for them – at least for now. But, even though Treasury’s decision is a sugarplum for some, it will we think prove a big lump of coal for those hoping for anything resembling a private U.S. residential-finance market.

First, though, to why what Treasury did is so good for the Fed. As clients know, the central bank throughout the crisis has done far more than anyone thought it would and some believed it could under governing law. That all of this was for the good may well prove the case, but it has also indubitably taken the central bank far, far afield from its monetary-policy mission. The Fed wants to go back to its core role as fast as possible, transferring the risk it now holds to stabilize financial markets over to the Treasury, where it rightly belongs. Although the Board has focused in public on ensuring the “exit strategy” is done carefully to ensure calm markets, it privately has put a lot of effort into figuring out how to defend itself against Congressional attack based on the Board’s foray outside its traditional realm.

The Treasury’s GSE policy is a big help to the FRB on this front in two ways. First, the unlimited backstop provides a full-faith-and-credit guarantee for the $1.25 trillion of GSE  obligations the FRB took on its books to stabilize mortgage finance. Without Treasury’s unlimited commitment, the GSEs could well have run quickly through the $289 billion remaining in the $400 billion Treasury line, forcing a receivership that endangers the Board’s debt and MBS holdings. Now, that can’t happen.

Another aspect of the Treasury decision gives Fannie and Freddie lots more room in their portfolios to hold assets. This too is a big help to the Fed. The Board now isn’t just fully protected from risk, but also able to reduce its holdings of GSE obligations secure in the knowledge that the GSES – backed of course by Treasury – can pick up the slack to keep rates down and promote market recovery. This pushes a critical non-monetary policy goal off the Fed’s hands back to Treasury – just where the central bank wants it. However, while all of this is good for the Fed, it’s far from good when one steps back from the current crisis to contemplate the U.S. mortgage market to come. As a result of Treasury’s action, the GSEs are in conservatorship in name only. There’s nothing about the GSEs that permits a return to private shareholders – the point of a conservatorship under current law. Instead, the GSEs are now not only the de facto wards of the state they were before Treasury’s unlimited commitment, but de jure ones as well. We see no way any private-shareholder owned entity – utility included – could succeed Fannie or Freddie because of the hundreds of billions of dollars in obligations it would take on.

There is, we think, now no way out for Fannie and Freddie except into some form of government agency that keeps them as is to promote Treasury’s foreclosure-prevention objectives for as long as Treasury wants them to do this. Then, they could be liquidated and some new securitization structure could take over, but we see no way that the GSEs could then be anything like what they were. We’ll turn to what they might be in a future client note, but – whatever it is – the fate of private mortgage lenders, insurers securitizers and investors hangs in the balance.