The eventual dissolution of Fannie Mae (FNMA 1.51%) and Freddie Mac (FMCC 1.63%) began to look a little more likely last week, after President Barack Obama spoke at a Phoenix, Ariz. high school and threw his support behind the push to take those entities out of the housing picture.
In his speech, Obama stated that mortgage financing reform should consist of some basic precepts: The private sector should be the mainstay of the mortgage market; taxpayers should never again be expected to bail out the home loan industry; and the 30-year, fixed-rate mortgage must be preserved. Altogether, these principles should support an affordable home-buying environment, especially for first-time borrowers.
Unfortunately, I don't believe that the last two things are possible if Fannie and Freddie go away -- particularly with the legislation on tap to wind down these entities -- and here are two reasons.
1. 30-year, fixed-rate mortgages would soon become unaffordable
The Housing Finance Reform and Taxpayer Protection Act, put forth by Senators Bob Corker and Mark Warner, would wind down Fannie and Freddie over a five-year period, putting in place a new entity called the Federal Mortgage Insurance Corporation. The FMIC would provide insurance for mortgage-backed securities, collecting money from the MBS-makers in order to take the onus off of taxpayers.
This sounds swell, except for a couple of things. One is that the bill allows financial companies to engage in every aspect of the mortgage investment machine. Institutions would be able to originate mortgages, service them, bundle mortgages into bonds, and collect the private capital for the backstop insurance. As Moody's Chief Economist Mark Zandi notes in a recent research paper, this would put the largest banks in a position to overshadow smaller institutions, stifling competition.
The likely contenders for mortgage-business domination would be familiar names: Wells Fargo (WFC 2.74%), JPMorgan Chase, U.S. Bancorp, and Bank of America. These banks were four of the top five mortgage lenders in 2012, and were also in the top five ranking for having the largest mortgage servicing portfolios, with Citigroup rounding out the latter list.
How affordable would 30-year mortgages likely be with such a small pool of players controlling the whole ball of wax? Not very, I'm sure.
2. Investor interest in long-term, fixed rate mortgages would be non-existent
With Fannie and Freddie backing 90% of all mortgages, it's not surprising that investors have had no qualms about buying MBSes made up of 30-year, fixed-rate loans. Without the current implicit guarantee of payback in times of crisis, however, I seriously doubt investors would want to take a chance on such a long-term investment -- particularly one so interest-rate sensitive.
Indeed, considering the clause in Corker-Warner that enables the government to completely privatize the entire process after eight years, I can foresee all fixed-rate mortgages falling by the wayside, eventually. After experiencing the financial crisis, who in his right mind would want to hang onto an investment vehicle underpinned by 30-year loans -- and no guarantees?
An unnecessary step
If these two institutions are put out to pasture, the entire mortgage landscape will change, and not for the better. Without Fannie and Freddie, I see little chance of a long-lasting housing recovery, as many fewer people will be able to afford a home.
While I understand the need to avoid another bailout of the GSEs, doing so doesn't necessitate the disassembly of Fannie and Freddie. They didn't cause the crisis, and though dissolving them will put the threat of losses on investors rather than taxpayers, this fix smacks of throwing the baby out with the bath water. No one wants a rerun of the financial meltdown, but simply excising Fannie and Freddie from the system seems like overkill, particularly when doing so will likely have such far-reaching ramifications.
The system worked for many years, making home ownership a reality for the masses, thus creating the American Dream. Instead of reacting to the Fannie and Freddie rescue as an opportunity to deposit blame, government should concentrate on making the GSEs work as they were intended -- benefiting both home buyers and investors.
