In a speech last week President Obama endorsed reducing the role that the United States government plays in the housing sector. One way he proposed to do that is by closing the doors of Fannie Mae (Federal National Mortgage Association, FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation, FHLMC).
“They’re not really government but not really private sector; they’re known as Freddie Mac and Fannie Mae,” Obama said. “For too long, these companies were allowed to make huge profits buying mortgages knowing that if their bets went bad taxpayers would be left holding the bag.”
For decades, Fannie Mae since 1938 and Freedie Mac since 1970, these two entities have bought mortgages from lenders that conformed to a set of lending guidelines essentially guaranteeing those mortgages and allowing banks to take the proceeds from the sale and lend the money again. If lenders were to lose the “guarantee” that they could sell their conforming mortgages to FNMA and FHLMC many fear we could see a rise in interest rates and the disappearance of the 30 year mortgage.
Higher interest rates appear to be unavoidable in any scenario where Fannie Mae and Freddie Mac cease to exist. Mark Zandi, Moody Analytics chief economist was quoted was quoted by the Associated Press as having said, “It will mean higher mortgage rates. The question is, how much higher.” At this early point in the discussion many economists believe mortgage rates would be one half of a percentage point higher without the government sponsored enterprises.
A lack of government guarantees could also make 30-year fixed-rate mortgages much harder to find. Banks would be less willing to offer those products without government support because the conventional mortgage as we know it is not a “money maker” for financial institutions. Just take a look at the terms offered for commercial mortgages (which are not backed by a government sponsored entitiy) to see what mortgages could look like without Fannie Mae and Freddie Mac. Commercial mortgages are most often amortized over shorter periods (20 – 25 years) with the interest rate only fixed for 5 years at a time.
For his part, Obama said he wants to preserve borrowers’ access “to safe and simple mortgage products like the 30-year, fixed-rate mortgage.” That would mean that the U. S. government can’t totally wash it’s hands of the mortgage finance system. President Obama seems to favor a solution along the lines of a bill introduced to the U. S. Senate in June.
Senators Bob Corker and Mark Warner’s bill proposes Fannie Mae and Freddie Mac be replaced by a Federal Mortgage Insurance Corp. that would continue efforts to build a common securitization platform to help small lenders issue securities. It also would continue the two companies’ existing guarantees. Under the bill private lenders (banks) would be required to hold 10% of the amount of the loan in equity capital to cover any first loss of the loans.
The Federal Mortgage Insurance Corp would be modeled after the Federal Deposit Insurance Corp. It would collect insurance premiums from the industry and maintain an insurance fund. The FMIC’s insurance would kick in only after a “substantial amount” of private capital is exhausted to “bring in credit investors who bear the risk of default while maintaining liquidity for the housing finance system.”
The House of Representatives is reportedly also working on a bill to reform housing finance but as of this writing details of the bill were not available.