Opinions Are Free, But GSE Reform Will Likely Be Expensive


Now that the Mortgage Bankers Association (MBA) has announced its proposed fix for Fannie Mae and Freddie Mac, industry experts are offering various opinions concerning the future of the government-sponsored enterprises (GSEs). Although most agree that there will be changes, some think it will take a while.

Although the full version of the MBA’s “GSE Reform Principles and Guardrails,” prepared by the MBA’s Task Force for a Future Secondary Mortgage Market, will not be available until April, the association recently offered some highlights of what the future end state should be built upon.

Among the principles are the following: preserving the 30-year, fixed-rate, single-family mortgage; maintaining a deep, liquid to-be-announced (TBA) market for conventional single-family loans; an explicit government guarantee of eligible MBS-backed mortgages; addressing the availability of affordable housing; and equitable, transparent and direct access to secondary market programs for lenders of all sizes and business models.

Among the guardrails are the following: more than two guarantors to become approved to issue guaranteed mortgage-backed securities (MBS); guarantors should be stand-alone companies; and guarantors must ensure equitable, transparent and direct access for lenders of all sizes and types.

A.W. Pickel III, president of the Midwest division of AmCap Mortgage LTD and one of the members of the task force, is confident the plan will work. (A list of the other members can be found here.)

“One of the things that is in there is a full government backstop,” he says. “Taking that away would be an instant shock to the system.”

Pickel, who stressed that he is speaking for himself and not for the MBA, tells MortgageOrb that the level playing field idea is another positive. “In the past, what happened was the more you sold to Fannie and Freddie, you got different treatment,” he says. “The part of the utility model that we like is it’s a utility for lenders of all shapes and sizes.” Also, with the introduction of additional entities, the duopoly would end.

There is, however, a downside to the MBA’s plan, at least for some. The investors who were affected by the net worth sweep would not be able to recoup. “I don’t think that is in any plan out there, except recap and release,” Pickel says. “The investors are large funds on Wall Street at this point. They are pushing for that.”

That, however, could end up being a moot point, considering that a federal appeals court this week issued a ruling that barres most legal claims by investors in the GSEs who alleged the U.S. government illegally seized billions of dollars from the firms via the “sweep.” That ruling now leaves shareholders with limited room to pursue some claims for monetary damages, according to a MarketWatch report.

The MBA plan notes that “recap and release,” which refers to allowing the two entities to rebuild capital and then get out of conservatorship, would be a piecemeal approach that would not be a permanent solution or make structural reforms “that would address the deficiencies that contributed to the failure of the GSEs.”

The government backstop is the key principle, says Bonnie M. Wongtrakool, a portfolio manager with Western Asset Management Co. “Without that, you are not going to have a TBA market, and allowing TBA originators to sell loans forward allows them to hedge their interest rate risk because of this market,” she says.

Wongtrakool adds that the 30-year mortgage would not exist without government involvement. “You need to have something in place, some mechanism for government to come in if there was another large downturn,” she says. “If you take the government backstop out, the entire credit risk would be borne by private investors, and for that credit risk, investors are going to require higher yield on securities, which will mean higher mortgage rates to homeowners.”

What MBA envisions, Wongtrakool says, builds upon what is working now. For example, Fannie and Freddie are piloting credit risk transfer deals. “There is a lot of potential for change,” she says. “The idea that they would go beyond fixing and doing something else is exciting.” She adds that change will occur slowly, as the current administration is likely to focus more on headline-grabbing issues, such as the Affordable Care Act and tax reform, two topics that voters will likely perceive as more relevant to their pockets.

Others maintain that the government should get out of the mortgage business.

“The MBA plan is a classic example of ‘rent seeking,’ the practice of manipulating public policy as a strategy for increasing profits at taxpayer expense,” says Anthony B. Sanders, professor of finance at George Mason University. “It is not surprising that a trade organization composed of mortgage lenders would insist on an explicit government guarantee for federal agency mortgage-backed securities, both owner-occupied and rental properties.”

Sanders also notes that not having direct guarantee of agency MBS will lead to an increase in mortgage rates. “But perhaps normalization of mortgage rates to a long-term average, say eight percent, would take some of the air out [of] home prices,” which, he adds, are unaffordable to many households in the U.S.

“Why doesn’t the federal government just get out of the mortgage business, where it has been since the Great Depression? Because rent-seeking is profitable,” he says. Also, housing groups and think tanks are still lobbying for guarantees.

Separately, Moody’s Investors Service issued a report in December noting that the GSEs will likely not be privatized and that doing so would be expensive. In “Privatizing Fannie Mae and Freddie Mac Would Be Credit Negative for Bondholders,” analyst Brian Harris writes that privatization would increase the risk of funding disruptions, “owing to the many questions about how privatization would occur, given the amount of debt the GSEs must refinance.”

The debt, the author writes, totaled $351.6 billion as of third-quarter 2016 for Fannie Mae, while for Freddie Mac, the debt totaled $378.1 billion. “Furthermore, Fannie Mae had $51.4 billion of discount notes outstanding as of the end of the third-quarter 2016, while Freddie Mac had $69.3 billion outstanding.” The GSEs would have to emerge from conservatorship, in which they have been since 2008, with sufficient capital so that the debt markets will continue to fund them.

Moody’s believes any change in the GSEs’ current setup is unlikely to occur over the next 12 to 18 months. “We believe that there is a very low probability that the GSEs will be privatized over the next few years, given their capital needs and complexities of privatization,” Harris writes.

Fannie Mae this past week reported annual net income of $12.3 billion and annual comprehensive income of $11.7 billion for 2016.

For the fourth quarter, the company reported net income of $5.0 billion and comprehensive income of $4.9 billion.

The company reported a positive net worth of $6.1 billion as of Dec. 31, 2016. As a result, the company expects to pay the Treasury a $5.5 billion dividend in March.

With the expected March dividend payment, Fannie Mae will have paid a total of $159.9 billion in dividends to the Treasury.

Freddie Mac reported net income of $7.8 billion for 2016 compared with $6.4 billion for 2015. The company also reported comprehensive income of $7.1 billion for 2016 compared with $5.8 billion for 2015.

Freddie Mac is scheduled to pay a dividend of $4.5 billion to the Treasury in March, based on its net worth of $5.1 billion as of Dec. 31, 2016, less its current required capital reserve of $600 million, which will be drawn down to zero by 2018.

Including the scheduled March dividend obligation, Freddie Mac has paid a total of $105.9 billion to the Treasury.

Nora Caley is a Denver-based freelancer.

Notify of
Inline Feedbacks
View all comments