Solving the Fannie and Freddie Puzzle
The nation’s $10 trillion housing finance system needs reform, but there’s little agreement about what reform should look like.
Congress continues to debate proposals and legislation for overhauling the U.S. housing finance system and resolving the longstanding federal conservatorship of Fannie Mae and Freddie Mac.
There’s general consensus that while the private sector must play a greater role in mortgage financing, some level of federal support is essential to mortgage market stability and liquidity.RELATED:
Reform could have a significant impact on credit union mortgage lending operations and earnings.
Many industry stakeholders believe changes to these government sponsored enterprises (GSEs) must take place, but it’s unclear what those changes might look like.
Fannie and Freddie play a pivotal role by fostering a secondary market for mortgages, which in turn expands access to housing for millions of Americans.
These entities don’t make loans. They buy them from lenders, package them as bonds, and guarantee them against default. Together, Fannie and Freddie own or back about half of all U.S. home loans.
On Sept. 7, 2008, the federal government placed Fannie and Freddie into conservatorship (allowing the government to administer the agencies) because defaulting loans threatened their solvency. The Treasury Department injected $189.4 billion to rescue the failing organizations.
In exchange for the cash injection, Treasury obtained preferred shares carrying a pidend of 10% and approximately 80% of common stock.
In the meantime, new regulations limited potential competition. This gave Fannie and Freddie even greater market power: Their insurance revenue has doubled, and the GSEs now purchase 80% to 90% of all new first mortgages.
With the turnaround in the housing market and rising home prices, Fannie and Freddie now are turning a profit. As of December 2013, Fannie Mae will have paid the Treasury Department $114 billion in pidends, slightly less than Treasury’s $117.1 billion holdings. Freddie Mac has paid $71.3 billion in pidends, compared with the $72.3 billion Treasury injection.
With Fannie and Freddie earning approximately $10 billion each quarter in profits, Treasury is expected to recoup its initial investment by early 2014.
It’s important to note that none of the pidend payments go toward paying back the $189 billion infusion of aid, which was in exchange for the preferred shares. Neither housing agency has the option to buy back the shares. Therefore, the pidends provide a substantial financial boon to the government.
Many believe Fannie and Freddie should be split into smaller stand-alone mortgage securitizers, none of which would be “too big to fail.” As such, there would be no implicit government guarantee of their liabilities and no subsidized funding from the private sector in the form of below-market interest rates.
Conservative members of Congress generally favor shutting down Fannie and Freddie and allowing the private sector to run the $10 trillion housing finance system. More liberal members of Congress believe there’s a role for government to ensure the availability of mortgage credit for all borrowers, especially less-affluent consumers.
One reform proposal calls for a full wind-down of Fannie and Freddie over five to seven years. Another plan involves privatization backed by government insurance (Senate Bill 1217—the Housing Finance Reform and Taxpayer Protection Act).
SB 1217 would replace the Federal Housing Finance Agency with a new entity called the Federal Mortgage Insurance Corp. (FMIC). This agency would provide insurance on certain mortgage-backed securities and would regulate the secondary mortgage market. The legislation would also create a mutual securitization company designed to help small lenders access the secondary mortgage market.
Still other proposals would gradually lower the conforming loan limits of Fannie and Freddie over time, allowing the private sector to come in and pick up that business.
NEXT: Principles for reform
Principles for reform
CUNA supports the creation of an efficient, effective, and fair secondary market with equal access for lenders of all sizes. To this end, CUNA supports these 10 principles for GSE reform:
1. Neutral third party. The secondary market must have a neutral third party with the sole role of providing a conduit to the secondary market. This entity would be independent of any firm that has any other role or business relationship in the mortgage origination and securitization process.
2. Equal access. The secondary market must be open to lenders of all sizes on an equitable basis. Guarantee fees or other premiums should not have any relationship to lender volume.
3. Strong oversight and supervision. The new entities should be subject to appropriate regulatory and supervisory oversight to ensure safety and soundness.
4. Durability. The new system must ensure mortgages will continue to be made to qualified borrowers even during troubled economic times.
5. Financial education. The housing finance system should emphasize consumer education and counseling to make sure borrowers receive appropriate mortgages.
6. Predictable and affordable payments. Consumers should have access to products that provide for predictable, affordable mortgage payments (such as the 30-year, fixed-rate mortgage) to qualified borrowers.
7. Loan limits. The system should apply a reasonable conforming loan limit that takes into consideration local real estate costs in higher-cost areas.
8. Affordable housing. Government support for affordable housing should be a function separate from the responsibilities of the secondary market entities.
9. Mortgage servicing. Credit unions should continue to be able to provide mortgage services to members in a cost-effective, service-oriented manner.
10. Smooth transition. The transition from the current system must be reasonable and orderly.
To minimize market disruption, CUNA suggests that Fannie Mae, Freddie Mac, and the FMIC be allowed to operate simultaneously so all parties can get acquainted with the new system.
“Ideally, market participants will not notice any sudden changes on the day the GSEs are shuttered and the new system takes over,” Bill Hampel, CUNA’s senior vice president/chief economist said during a Senate hearing in November. “The many changes necessary to move from the old to the new system would already have happened gradually during the transition.”
Political incentives for reform
Many in Congress do not want taxpayers to be exposed to future losses if the housing market takes a turn for the worse. They believe private capital should take the first hit in that event.
But with much of GSE profits now going to the federal government as pidends—and in turn reducing federal deficits—there may be little incentive to eliminate this cash cow any time soon.
Moreover, the housing and mortgage markets are a complex and important part of the nation’s economy. Any reform process will not happen quickly.
So despite the recent congressional activity, it could take years before any GSE reform legislation becomes law.
STEVE RICK is CUNA’s senior economist. Contact him at 608-231-4085.