It’s no secret the role of government-controlled mortgage finance companies Fannie Mae and Freddie Mac has grown out of control.
Reuters says Fannie and Freddie now back 85 percent of new mortgages.
According to Bloomberg, between the two companies and the Federal Housing Administration the three groups own or insure almost 97 percent of all mortgage bonds.
The fate of the mortgage giants has been discussed for a while now, but today action has been proposed.
Treasury Secretary Timothy Geithner announced his recommendation for the future of Fannie Mae and Freddie Mac, and it involves a lot less involvement for the government-controlled mortgage finance companies.
The Obama administration supports this proposal to “wind down” the market share currently held by the government mortgage buyers, but says we should continue to count on Fannie and Freddie as a “backstop” in times of crisis.
The proposal offers three long-term options to reduce the government role and a few short-term steps to raise the cost of government-backed mortgages.
“We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market,” Treasury Secretary Timothy Geithner said in a statement.
Geithner warned that change won’t happen overnight and no matter what option the politicians choose the government’s role in the mortgage market will never disappear entirely.
Nancy Vanden Houten, Senior Analyst, Stone & McCarthy said, “The big overhaul to the housing finance system is going to take a long time and it’s going to be influenced a lot by politics.”
The two companies—known as government-sponsored enterprises (GSEs)—would be wound down gradually and replaced by private capital, under three possible scenarios sketched out in the White House’s set of proposals.
When they were created the two companies insured bond buyers against losses, with an implied promise that the U.S. government would make investors whole if the system failed.
Today, taxpayers have been supporting Fannie Mae and Freddie Mac to the tune of $150 billion since September 2008.
All three of the options proposed today would end taxpayer support.
The Three Options
Involves a “privatized” system of housing finance and little help from the government. In this options the government’s only role is to help “narrowly targeted” low-income and veteran buyers.
This option would replace Fannie and Freddie with a system aimed at helping low-income and veteran buyers (FHA’s traditional target) in normal times and also provide a backup in a crisis. According to the Treasury Department this option is possible through the use of high-priced guarantee fees and restricted amounts of public insurance.
Big Government Role
The third option most closely mirrors the current system for the GSEs. Option three would impose even more regulation on Fannie Mae and Freddie Mac and carve out the government’s role as “catastrophic reinsurance behind significant private capital.”
- Increase the monthly insurance premiums, or guarantee fees, now charged by Fannie Mae and Freddie Mac. Higher premiums would in theory give other companies incentive to compete for lending.
- Increase Federal Housing Administration premiums by .25 percent/lower the ceiling for loans that Fannie Mae and Freddie Mac can insure. Jumbo loans are currently capped at $729,750 but are scheduled to fall to $625,500 on Oct. 1 if Congress doesn’t act.
- The administration also endorsed an existing law that forces the GSEs to shed loans in their $1.5 trillion portfolios by 10 percent a year as a way to reduce government exposure to failing mortgages.
- Phasing in higher pricing for Fannie, Freddie to a level even with private sector. This move would take place over several years.
The release of the report by Geithner and HUD head Shaun Donovan marks the beginning of a likely embroiled battle and political debate over how to fix the mortgage-finance system.
Geithner warns that political deliberations can’t take too long. He is calling on Congress to legislate “some time over the next two years”.
Some housing and consumer advocates are afraid of a fast government withdrawal, worrying it may put homeownership out of reach for many borrowers and give too much power to financial companies, but other experts says the change is long overdue.
For Chris Rupkey, Cheif Financial Economist Bank of Tokyo-Mitsubishi, the writing has always been on the wall, “The Treasury has been warning about the risks from Fannie and Freddie ever since the late 1990s. The fact that they were undercapitalized during the height of the bursting of the housing bubble certainly helped to undermine and add to the general downturn in the market. Anything that gets this issue behind us would be a good thing.”
Paul Ballew, Chief Economist, Nationwide Insurance agrees, “Housing’s at or near bottom, if we’re going to make changes, now’s the time.”
UPDATE: Industry Reaction to Obama Admin Proposal to Phase Out Fannie Mae and Freddie Mac
Hours after Treasury Secretary Timothy Geithner unveiled the Obama Administration’s proposal to “wind down” the market share currently held by the government mortgage buyers Fannie Mae and Freddie Mac real estate industry insiders are already firing back with complaints and disbelief.
The California Association of Realtors (CAR) released a statement that phasing out Fannie and Freddie would ultimately hurt the housing recovery.
California makes up 50 percent of the current top 10 list for most foreclosed upon cities in 2010. However, two California cities sneaked into the top 10 for cities with the highest increasing home values year-over-year according to Zillow’s 4Q 2010 report.
Regardless of any increasing home values, the CAR doesn’t seem to think California will be able to survive in a real estate world with a little less Freddie and Fannie.
- Without a secondary market, mortgage interest rates would be unnecessarily higher and unaffordable for many Americans. In addition, an inadequate secondary market would impede both recovery in housing and the overall economic recovery.
- Government-sponsored entities have a separate legal identity from the federal government but serve a public purpose. Unlike a federal agency, the entities will have considerable political independence and be self-sustaining, given the appropriate structure.
- The White House’s proposal to allow the maximum loan limit to drop back to $625,500 in high cost areas also would hamper California’s housing recovery. Analysis by C.A.R. shows that a reduction in the conforming loan limit to $625,500 would render the percentage of home sales ineligible by the following:
|County||% of homes ineligible for GSE financing||% of homes ineligible for FHA financing|
|San Francisco County||8%||12%|
|San Diego County||3%||8%|
- California dominates the jumbo loan market and cannot afford a reduced loan limit.
- The homeownership rate here consistently has lagged behind national figures for the last three decades
Great summary on an important development. I say let the government go back to the FHA program. It is ludicrous to think that they back a majority of the mortgages out there.
Home ownership may not be for everyone. Next step: fix the tax code!!
Good article, I say end tax payer support and let’s go back to the FHA program that was working before the housing bubble burst.
It will be interesting to see which option they decide to go with, in the meantime I still think its a tricky time to own or sell a house.
One benefit of going back to the FHA program of before is that we can now avoid the dumb lending mistakes. The market is, however, turning up due to the security of the GSE programs. Rates are rising and people are starting to look to buy and invest in houses (believe it or not)…if you take away government security too fast, the market could crash again because there needs to be trust built in the competitive mortgage firms in order for people to buy
Thanks for bringing much needed clarity to the often confusing area of financing home ownership. I was surprised at how heavily invested in mortgages the US government is and how complicated the ability to change the current system will be.