Overhauling Fannie Mae and Freddie Mac Won’t Be Easy or Cheap

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Two government-sponsored entities (GSEs) hold about half of the nation’s mortgage debt. Fannie Mae and Freddie Mac, as the GSEs are known, were placed under Department of the Treasury conservatorship in 2007 when the federal government rescued the two agencies with $191 billion in bailout funding.

Although these GSEs are once again profitable and have paid the Treasury more than $300 billion in dividends over the past several years, they remain under Treasury control and taxpayers may have to bail the firms out once more if the U.S. housing market turns sour again.

For more than 10 years, there have been discussions about what to do with Fannie and Freddie, and the Trump administration has finally delivered a plan it claims protects taxpayers against future bailouts of the GSEs, preserves the 30-year fixed-rate mortgage and “helps hardworking Americans fulfill their goal of buying a home.”

The administration’s plan has three major components: return Fannie and Freddie to private control after recapitalizing them, create an explicit federal guarantee of the mortgage-backed securities issued by the GSEs and create more private companies to compete with Fannie and Freddie for mortgage purchases.

The bonds issued by Fannie and Freddie have never had an explicit guarantee backed by the federal government, but investors always acted as if such a guarantee was in place. As it turns out, when push came to shove during the housing crisis, investors were right. Making the guarantee explicit may be required in order to attract investors to the GSE bonds. The administration’s plan would extend the federal guarantee to “any other FHFA-approved guarantors of [mortgage-backed securities] collateralized by eligible conventional mortgage loans or eligible multifamily mortgage loans (each GSE and competitor, a ‘guarantor’).”

Before that happens, the U.S. Senate and the House of Representatives will have to agree on what role the GSEs play in the U.S. housing market. Democrats who control the House want the companies to increase the number of less-wealthy borrowers who want to buy homes. Republicans who control the Senate generally resist affordable-housing policies, and some want the federal government out of the mortgage market altogether. This is the big reason that the GSEs remain under the Treasury’s thumb 11 years after being put there.

Recapitalizing Fannie and Freddie won’t come cheap either. Existing investors, including Bill Ackman’s Pershing Square Capital Management and Bruce Berkowitz of Fairholme Funds, will expect a big payday for holding onto shares they bought for pennies in 2008 and still own. Fannie and Freddie could recapitalize themselves, but that could take another decade. That leaves either another infusion of federal funds or privatization of one or both GSEs. A total of $200 billion in recapitalization funding is not out of line, and the total could go higher.

Creating more competitors in the secondary mortgage market would have “several compelling benefits,” according to the Treasury report. Among these are helping protect taxpayers against bailing Fannie and Freddie out of the soup again, leveling the playing field for private competitors by guaranteeing private sector loans as well as GSE loans, subsidies on loans would be passed through to borrowers rather than shareholders and promoting innovation in the mortgage lending business.

The Treasury Department’s proposal is long on generalities and short on specifics. Bill Alpert at Barron’s noted 242 appearances of the subjunctive “should,” compared to just 23 occurrences of the active “will.” Given the bitter political division in the federal government, it is unlikely that a major overhaul will take place ahead of the 2020 elections, although there are some things the administration can accomplish by executive order. Even if the political divide magically disappeared, the details missing from the Treasury report could take years to iron out.

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