I see no real plan for Fannie and Freddie

What’s going on across the Pond

Paul Muolo

Over the past few months the worst kept secret in Washington is the fact that the Obama White House has been mostly clueless about what to do with Fannie Mae and Freddie Mac, the government owned mortgage behemoths that have been bleeding red ink for two-plus years now.

Then again, the White House shouldn’t really feel bad about the situation because as any educated mortgage banker can tell you, Fannie and Freddie are a conundrum.

Although they’ve been under a federal conservatorship for 30 months now, they purchase 70% of all residential loans originated in the US. Without them, there would be no mortgage market.

Also, take these two government sponsored enterprises out of the picture and, rest assured, home values would collapse.

Since the housing bubble began to burst in late 2007 home values, which in general are based on a national average, have fallen by 30% from their peak, worse than the declines suffered during the Great Depression.

The problem with coming up with a plan, especially one that relies heavily on private sector banks and bond guarantors, which is what many Republicans favour, is that if it doesn’t work mortgage liquidity might dry up further – even for borrowers with good credit scores and downpayments north of 10%.

The thought that American banks can return to the days of holding loans on their balance sheets might seem like an idea whose time has come again, but the issue is that borrowers here prefer 30-year fixed rate loans, and funding such an asset with short-term deposit accounts just won’t work.

The problem is this: the housing and mortgage industries have already suffered enough pain

After what banks and thrifts have been through during the past three years the idea of trying such a financial strategy would go over, to borrow a phrase, like a lead balloon.

So, does the Obama White House have a plan?

Washington lobbyists and analysts believe that by mid-February a working paper will be released listing options to replace and restructure Fannie and Freddie with an eye toward reducing their size or phasing them out over time.

Chances are, one of those options will entail merging the two, while reducing their authority to guarantee better credit quality loans, leaving this low hanging fruit to the private sector.

It’s also likely that what’s left of Fannie and Freddie might be merged with the Government National Mortgage Association, which is part of the US Department of Housing and Urban Development, a cabinet agency that is funded directly by US taxpayers.

GNMA guarantees the underlying loans that Fannie and Freddie don’t purchase, accounting for most of the rest of the market.

At this point, and in the vacuum of there actually being a public plan we can all look at, it’s all talk. Very little has leaked out to the press about ’the plan’.

Rest assured, whatever is proposed will be phased in over many years, perhaps even a decade, so as not to bring the fragile US housing market to a grinding halt.
It’s worth noting that it’s also possible that Fannie and Freddie will turn a profit this year, changing the debate somewhat.

Meanwhile, the Republicans now officially control the House of Representatives, and whatever plan is floated will need their blessing.

The Good Old Party has never been a big fan of government sponsored enterprises and have traditionally believed that housing in America receives way too much government support in the form of tax breaks and incentives.

Republican Congressman Randy Neugebauer of Texas, who chairs a key House subcommittee, has emerged as a key player in the public debate over Fannie/Freddie.

During a recent speech in Washington he made it clear that in his mind most of the mortgage market, including secondary market funding, should be in the hands of the private sector.

A former home builder and lender from the Lone Star State, he remembers that back in the 1970s Fannie and Freddie accounted for a smaller share of the market and that private banks and investors bought loans from each other all the time.

“We need the market to determine what the risk premium is for mortgages, not the federal government,” he told a group of academics, policy wonks and lending professionals.

Then again, the 1970s were long before the housing bubble burst.

He admits that it won’t be easy shifting the market over to private firms, an adjustment he says will be painful.

But whether Neugebauer knows it or not, the problem is this: the housing and mortgage industries have already suffered enough pain.

Whatever the government proposes and adopts regarding Fannie and Freddie has to work the first time. There will be no second chances.