Under President-elect Donald Trump, the government’s conservatorship of Fannie Mae and Freddie Mac could become a thing of the past. The question is if the 30-year fixed rate mortgage would be, too.
Earlier this month, Brian Brooks, former Comptroller of the Currency and current Trump transition advisor, said it was “highly likely” that the incoming government would move to privatize the mortgage market makers, noting that it was the “last piece of unfinished business” from the 2008 financial crisis.
But some economists and lenders say such a move could have devastating consequences for the mortgage market. Specifically, they worry that if the government relinquishes its ownership stake in Fannie and Freddie, investors would no longer treat debt and securities issued by the entities as fully backstopped by the public.
“We haven’t had bank market mortgages in this country in 100 years,” said R. Christopher Whalen, a risk analyst and former investment banker. “The only way you have 30-year mortgages with the current amortization that we have today is with government backing.”
Meanwhile, proponents of a swift end to conservatorship argue that little will change upon the release of the government-sponsored enterprises.
Former Federal Housing Finance Agency Director Mark Calabria, who sought to end the conservatorship during the first Trump administration, pointed out that the government has never explicitly guaranteed the mortgage-backed securities, also known as MBS, issued by Fannie and Freddie. Still, he noted, market participants treated those assets as guaranteed both before and during the conservatorship. He predicts the same will be true once it ends.
“The implied guarantee is just created by marketing participants,” Calabria said. “These very same people, post-conservatorship, will tell you that implied guarantee still exists.”
The American standard
The enterprises buy and guarantee principal and interest payments of mortgages that conform to certain standards. In doing so, they reduce risk for originators, expand the availability of credit and reduce costs faced by mortgage borrowers. Because their standards allow for 30-year fixed rate mortgages — a product scarcely offered elsewhere in the world — some economists and market participants credit them with enabling the structure to become ubiquitous among U.S. homeowners.
“A true privatization is probably not in anyone’s best interest at this point,” said Stuart Boesky, founder and CEO of the real estate private equity group Pembrook Capital Management. “Unfortunately, we’ve grown to love fixed-rate, 30-year mortgages. Our whole housing market is built around it, and I’m not quite sure a real privatization would sustain a 30-year fixed rate mortgage.”
But Calabria said the enterprises are not the sole reason for this distinctly American home loan, arguing that they do nothing to mitigate the duration or interest rate risks that come with such long-dated instruments. That risk is assumed by MBS investors, including banks.
“The primary reason that we have longer term financing on mortgages than other countries is because we have less of a history of inflation,” he said. “What’s so special about a 30-year fixed mortgage? The interest rate risk. Are you going to make a 30-year fixed rate loan if it’s an average of 10% inflation every year?
“Ultimately, it’s really an inflation question, not a credit question, because Fannie and Freddie do not guarantee interest rate risk. They guarantee credit risk,” he added.
Yet, such nuances could be lost once the process of privatization enters the public sphere. Whalen said he expects strong opposition to the move to arise on both sides of the political aisle.
“The moment they start this conversation, the moment the Secretary of the Treasury starts talking about this in front of Congress, the opposition is going to explode — not just from Democrats but Republicans, too,” Whalen said. “They’re going to start asking a lot of questions that they’re not asking now.”
Getting into (and out of) conservatorship
Fannie Mae, known formally as the Federal National Mortgage Association, was created by Congress during the Great Depression to bolster the secondary market for bank-originated mortgages and thus provide liquidity to lenders. The Federal Home Loan Mortgage Corp., or Freddie Mac, was created in 1970 to do the same for thrifts and smaller banks.
Both entities were chartered as private companies but with government-appointed directors, lines of credit with the Treasury Department and certain benefits such as tax exempt statuses and the ability to classify their issuances as government securities.
Fannie and Freddie have been under conservatorship with the FHFA since 2008, when losses from the subprime mortgage crisis pushed them to the brink of bankruptcy. The arrangement was intended to be a temporary stopgap to safeguard the mortgage market while the enterprises recapitalized. As part of the conservatorship, the Treasury Department owns preferred shares and warrants that could be converted into a 79.9% stake in the companies.
To be released from conservatorship, the enterprises must build up a capital buffer of at least 3% of their assets, which currently total roughly $8 trillion. They also must raise enough equity through a public offering to repurchase preferred shares from the Treasury at a cost of roughly $190 billion. The total price tag of the public issuance could be offset by the enterprises retaining earnings over a several year period, but will also be influenced by the expected returns of investors.
Some are skeptical about the feasibility of such a public offering, especially if the purchase would be taking on the risk of roughly half the U.S. mortgage market.
“I’m not quite sure there’s enough capital in the capital market system to privatize it and, if there is, I’m not sure the return on equity is going to be attractive enough to draw in that capital,” Boesky said. “It begs the question of whether it is possible to capitalize it the way it should be for it to be truly privatized.”
Calabria acknowledged that privatization would be no small feat, but argued that the process could be relatively simple. That’s because the enterprises are not large holding companies, they are not structurally complex and they do not require organizational changes. He added that they would have the benefit of being included in index funds immediately simply because of their size.
A recent report by the Congressional Budget Office noted that privatization is both possible and more viable today than it was when Calabria was in office. The CBO found that 60% of the 250 potential scenarios it analyzed this year would raise sufficient funds for privatization, compared to just 12% in 2020.
A worthy tradeoff?
Still, even if it can be done, some wonder whether it should, particularly given the unknown implications on mortgage costs and availability.
Mark Zandi, chief economist with analytics firm Moody’s, said there are a range of potential outcomes, including privatization with a government guarantee, either explicit or implicit; privatization without a guarantee; and a return to being government corporations, as Fannie was before 1968. Most of these options would increase mortgage costs at least slightly, Zandi said, adding that the most likely outcome is for the status quo to continue.
Zandi noted that the enterprises have taken steps to shield taxpayers from losses by offloading the interest rate risk for their nonsecuritized holdings to the private sector in the form of credit risk transfers. With this pseudo-privatization in place and the mortgage industry functioning well, he sees no reason to take on the risks associated with privatization.
“It’s a bad idea. I think it’s a solution looking for a problem,” Zandi said. “The housing finance system is functioning marvelously well and the housing finance ecosystem is in good shape. I mean, look at mortgage credit quality. It’s about as good as it gets.”
Brooks, now the CEO of the nonbank commercial real estate lender Meridian Capital Group, argued that the move would allow the government-sponsored entities to buy more commercial mortgages and spark more competition in the real estate finance space.
“In shareholder-owned structures at the agencies, you will draw much more capital into the real estate sector, generally, much more animal spirits, much more activity, and that is because those businesses themselves will be able to innovate,” Brooks said onstage during a commercial real estate event. “People will build companies to try to compete with them. The amount of global capital flowing into the U.S. real estate sector generally, will go up, not down.”
For Calabria — who said he does not intend to join the new Trump administration next year — the issue is a matter of enforcing the law on the books, which directs the government to release the GSEs once they are stable enough to stand on their own.
“My argument is simply, as a basic principle, government should follow the law, whether we like it or not,” he said. “Because Congress debated those trade offs and made the decision.”
