Congress will soon be debating possible changes to Fannie Mae and Freddie Mac, the government sponsored enterprises (GSEs) that purchase or guarantee mortgage-backed securities on the secondary mortgage market. Proposals for “reform” include possible legislation to phase out and eventually eliminate Fannie and Freddie altogether.
Elimination of the GSEs, which purchased or securitized two out of every three loans written in 2010, would have grave consequences for home buyers and sellers, the real estate market and the rest of the economy. Almost overnight, financing would dry up. Interest rates would increase and borrowers would be forced into the exotic loan products that helped create the current financial climate.
C.A.R. and NAR believe that Fannie and Freddie should be converted to government-chartered, non-profit corporations. Such an entity would ensure government’s role in a stable real estate finance system, while eliminating the conflict created by the GSE’s current charter allowing for a private profit and public loss structure.
What are Fannie Mae and Freddie Mac and what do they do?
Fannie Mae and Freddie Mac were chartered by Congress but are wholly owned private companies traded on the NYSE.
Fannie Mae and Freddie Mac were created to ensure that an affordable and stable flow of capital is available to lenders for home loans regardless of market conditions. When the housing market is in the middle of a down cycle, private investors are reluctant to purchase mortgage backed securities (MBS) that aren’t guaranteed or sold by the GSEs. This makes the GSEs the only reliable conduit of investment capital for housing during down markets.
Fannie and Freddie do this by operating in what is known as the “secondary mortgage market.” They purchase or guarantee securities backed by existing loans that the GSEs and lenders then trade on the secondary market. Lenders can then use that money to make more loans. By allowing lenders to sell their loans as opposed to holding onto them in their portfolios, the GSE are able to help supply a more constant flow of capital to the mortgage market.
The majority of Fannie and Freddie loans are fully documented prime-grade fixed- and adjustable-rate mortgages. Only a very small part of their portfolio consists of subprime or Alt-A mortgage products. Fannie and Freddie are currently experiencing significantlylower default rateswhen compared to the majority of private lenders in the mortgage market.
Why does the market need Fannie Mae and Freddie Mac?
Today, as we go through the most recent and perhaps worst housing downturn and credit crisis since the great depression, Fannie and Freddie have stepped in and continue to supply capital to the housing market.
Contrary to what many pundits are saying, the nation’s housing market needs and benefits from Fannie Mae and Freddie Mac continuing in their current roles. Fannie Mae and Freddie Mac were designed and chartered by Congress to operate as countercyclical entities, supplying capital to the mortgage market regardless of market conditions. When the housing market is at its worst, with Wall Street and private lenders unwilling or unable to supply capital, Fannie and Freddie step in to keep the flow of capital moving.
Without the stabilizing influence of the GSEs, the battered housing sector could experience an ever-worsening feedback loop of dwindling mortgage credit; lower home prices; and capital depletion of primary market lenders forced to take further markdowns on mortgage assets, posting increasing reserves for credit losses. In the current delivery cycle for mortgage assets, the loss of the GSEs would be truly catastrophic for the overall economy.
What would likely occur were the GSEs to be eliminated in their present form?
The effects of the elimination of Fannie and Freddie would be devastating and immediate. There would be an instant shortage of capital to the mortgage market as only FHA and VA would survive as a stable source of capital for homebuyers. Interest rates would sharply increase on all non-government mortgage products, sinking the nation’s housing market by sharply raising the costs of homeownership. Homebuyers would be forced into exotic loans again because they would be unable to afford the high initial costs of today’s non-conforming fixed rate mortgages. Without Fannie and Freddie meeting their affordable housing goals, many low- and moderate-income households will be unable to purchase homes.
C.A.R. and NAR continue to advocate for a responsible reform to the GSEs that ensures that the flow of capital continues to enter the mortgage market regardless of the state of the housing or mortgage markets or overall economy.