It’s been over a decade in the making, but an overhaul of Fannie Mae FNMA, -11.37% and Freddie Mac FMCC, -11.54% is finally in the cards.
The acting head of Fannie’s and Freddie’s regulator, the Federal Housing Finance Agency, told employees that he was working with Treasury Secretary Steven Mnuchin to get the two mortgage companies, currently under government control, to “operate independently,” as first reported by MarketWatch earlier in January.
The White House on Tuesday issued a statement saying it will work with Congress.
“The White House expects to announce a framework for the development of a policy for comprehensive housing finance reform shortly. At this time, no decisions have been made on any reform plan. As part of the process, however, the Administration will work with Congress to formulate a plan that fully addresses the risks to taxpayers presented by the current housing finance system and that improves the ability of creditworthy Americans to buy a home,” said White House spokeswoman Lindsay Walters in a statement.
Anything is possible now, from the contours of the future state of housing finance to how quickly it all gets done. So MarketWatch has decided to skip the usual “experts predict” story and instead outline the big questions facing the housing market and Washington now.
Will Fannie and Freddie stick around?
The 2008 law that put Fannie and Freddie into conservatorship in the first place specifies that the two companies must technically be liquidated if they are to exit government control, according to Karen Shaw Petrou, who runs financial services advisory Federal Financial Analytics. But as to what happens next, and whether the housing finance system is still underpinned by the powerful twins, is the biggest question facing the market right now.
“Is the plan simply to rebuild capital from the earnings they’re generating and at some point they’d be re-privatized? That’s ‘back to the future’ as fundamentally the same duopoly they were before the crisis. We’d be setting ourselves up for the same kind of crisis we had ten years ago,” said Mark Zandi, chief economist for Moody’s Analytics and an author of a 2016 proposal to overhaul housing finance.
Over the years that the two companies have been wards of the state, they’ve come to resemble utilities more than the freewheeling private enterprises of the bubble years. Some efforts are underway that take that transition even further. In his meeting with FHFA staffers, Joseph Otting, the acting agency head, referred to the “Common Securitization Platform,” an initiative that merges together Fannie and Freddie’s bond issuance, as something that gives comfort to the housing finance market.
But some housing watchers think a pro-business, pro-small government administration and regulator could take the process in a different direction, not “recapping and releasing” the GSEs, as Zandi suggested, but neutering them.
“If the administration comes in with a sledgehammer to eliminate the aspects of the system that provide broader access, whether eliminating low-down mortgages or reducing cross-subsidization even more than it’s already been reduced, that will results in mortgage credit deserts,” said Julia Gordon, executive vice president of the National Community Stabilization Trust, and a long-time advocate for fair consumer treatment in mortgage lending.
“Cross-subsidization” sounds convoluted, but it simply means that at their best, Fannie and Freddie operate like insurance companies, spreading risk broadly. They do that by charging higher fees to borrowers with better credit scores, trying to level the playing field for those whose credit isn’t as high.
Fans of limited government usually prefer what’s sometimes called “risk-based pricing,” which sounds efficient and logical, but could mean that higher-risk borrowers are locked out of ownership entirely. That isn’t helpful for either a robust housing market or for equal access to the American Dream.
The worst-case scenario, in a true limited-government approach, is that Fannie and Freddie wind up putting themselves out of business. In such a situation, the riskiest borrowers would only be able to access mortgages backed by the Federal Housing Administration, and the most pristine would get loans that banks keep on their balance sheets.
Such a move could hasten the ongoing hollowing-out of the middle class that concerns many advocates. “The GSEs have been a tremendous advantage for the way they combine risk on private capital with risk backed by the government,” Gordon said. “The last thing the middle class needs is another blow to their ability to have access to stable housing and wealth-building possibilities.”
Zandi believes that there could be immediate, tangible market reactions to a plan that scales back the government presence in the mortgage market.
“Right now the market is of the strong view that when it’s all said and done, the government will provide a guarantee for securities issued by Fannie and Freddie, but as soon as it starts pricing in the possibility that the government would not provide the same liquidity, that could be reflected in mortgage rates overnight,” he said.
Mortgage rates had been churning higher ever since the 2017 tax overhaul, but they plateaued late last year. The 30-year fixed-rate mortgage averaged 4.45% in the January 24 week, according to Freddie Mac.
How quickly will things move?
That’s not just an academic question.
“The speed of the entire process is important is because, as the administration knows, the economy isn’t getting any better,” Petrou said.
“Housing defaults and delinquencies are not going to stay where they are,” Petrou said. “They’ve been in conservatorship for a decade because we’ve been in a benign environment. The sooner they act, the more decisively they act, the more certainty the market has, and then the less systemic risk.”
Otting told employees that he expects it will take about six to 18 months to determine how much capital and liquidity the enterprises need.
Fannie and Freddie’s unique strength is that they make mortgages in good times and bad, whereas big banks tend clamp down on lending the minute things get bad, noted Rob Zimmer, head of external affairs for The Community Mortgage Lenders of America. Eliminating that buffer and relying only on the private sector would be very dangerous to the housing market. Still, he cautioned, it’s important not to let the GSEs go back to the Wild West days before the crisis, when they mimicked the private sector in a race to the bottom.
How much money do Fannie and Freddie need?
As a reminder, unlike most corporations, the two enterprises have almost no retained capital. That’s because of a 2012 agreement that amended the 2008 rescue plan to direct them to sweep capital to the Treasury Department. Under a deal between Treasury and Otting’s predecessor, late in 2017, they now hold the slimmest of capital – just $3 billion each.
As for the correct amount of retained capital in the future, “by a lot of analysis, it’s probably somewhere $150 billion to $200 billion,” Otting told FHFA staffers.
That’s an “actuarially correct amount of capital to hold,” especially given how pristine the GSEs’ lending patterns have been over the past decade, Zimmer said.
Zandi agrees. Under various stress test scenarios, he said, 3% to 4% of the enterprises’ assets would enable them to “easily digest what happened in the housing crisis.”
But for many housing-watchers, like Petrou, that’s, in her words, “way too low.”
Fannie and Freddie together have $5.4 trillion of assets, also known as their “book of business.” As Petrou points out, “the least the largest banks may hold is 5%.” Given their immense size, Petrou thinks regulators would do well to consider Fannie and Freddie in the same light as what are often called the “globally systemic important banks.”
The right amount is important because too little would put taxpayers at risk once again; too much would mean “unnecessarily denying good credit-risk families the chance to participate in the economy,” in Zimmer’s words.
There’s also a very important wildcard to whatever the White House is considering.
After a decade of dithering, it seems unlikely – and perhaps even a little cheeky – for legislators to finally wave a hand and try to block any administrative actions on reform.
But that’s what they seem to be doing. House Financial Services Chairwoman Maxine Waters, and Sen. Sherrod Brown, the ranking member of the Senate Banking Committee, jointly asked Otting what exactly the conservatorship is that they’re considering.
In a speech outlining her priorities, Waters notably did not rule out taking Fannie and Freddie out of conservatorship. She did say the “core principles” she advocates including maintaining access to the 30-year mortgage, ensuring sufficient private capital is in place to protect taxpayers and maintaining access for all qualified borrowers.
The White House statement says its plan will “fully” address the risks to taxpayers and improve the ability of creditworthy Americans to buy a home.