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Goodbye, Fannie and Freddie

Bill to Close Fannie Mae and Freddie Mac

Written by Brian Hicks
Posted June 26, 2013

The writing’s on the wall for Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FMCC). Senators Bob Corker (R-Tenn.) and Mark Warner (D-Va.) introduced their bill yesterday, the goal of which is to replace the two mortgage financiers with a government reinsuring agency.

fannie maeThe bill enjoys bipartisan support, and the general consensus across party aisles is that Fannie and Freddie should be “retired”, while the federal government maintains an active federal role in mortgage lending.

Bloomberg reports:

“There is a bipartisan effort here that’s thoughtful and it is without question the most thorough Congressional effort to draft a GSE reform legislation to date,” David Stevens, president and chief executive officer of the Mortgage Bankers Association, said in an interview.

Fannie and Freddie were both taken over by the government back in 2008. Although both have produced surprisingly good results of late, the terms of their takeover mean they can never quite buy back their independence from the government.

Quite aside from the central issue of mortgages, this bill is part of a broader effort to reform on a structural basis the U.S. domestic mortgage and housing systems. The bill allows for Freddie and Fannie to both be gradually dissolved over a five year term.

It’s true that banks with participation in the bad mortgages will consequently have to absorb losses; however, Corker believes this is a positive thing, since it negates any perceptions of “private gains and public losses”—in other words, it’s a good thing that the banks are facing consequences for their poor decisions in the past.

Under the terms of the bill, private financiers will need to hold equity capital equivalent to 10 percent of the principal of any underlying securities in order to cover any initial loan losses. This clause has come under criticism from entities involved in the home financing market, but the bill’s supporters have stood firm in their defense. What’s replacing Fannie and Freddie is, tentatively, the Federal Mortgage Insurance Corp., which would continue the work of Fannie and Freddie.

The FMIC, modeled after the Federal Deposit Insurance Corp., will continue to collect on insurance premiums and will maintain a dedicated insurance fund. This is to serve as a buffer of sorts in the event that a certain amount of private capital runs out.

In short, there are provisions for the FMIC to handle major losses in unusual circumstances—losses that could pose a risk to the housing and mortgage systems at large. However, this kind of emergency measure is to be limited to six months per three-year period.

Opposition to Dissolution

There has been opposition to the government’s plans to close down Fannie and Freddie, due largely to the aforementioned recent uptick in their revenues. Notable hedge funds like Paulson & Co. Inc. and Claren Road Asset Management LLC. have invested in the two have been lobbying against their shutdown.

The to-be-created FMIC will not only maintain the separate insurance fund I mentioned earlier for use in times of crisis; it would also continue buying home loans from their originators, guarantee securities (backed by mortgages) holders against losses, and generally promote affordable housing finances, reports ValueWalk. It’s a significant responsibility, since between Fannie and Freddie, more than half of all new domestic loans are handled.

 

While the new bill may be a welcome relief for the housing and mortgage markets, it is unlikely to light many smiles on the faces of Fannie’s and Freddie’s private stock holders, many of whom, like Paulson, sought to bet on their restoration to private autonomy due to the recent change in performance.

The conditions of the U.S. bailout for these two companies ended in the Treasury holding $188 billion in preferred stock, but any profits exceeding a threshold (required to sustain a capital buffer) are automatically returned to the government. And the Treasury can, if it wishes, obtain about 80 percent of all common stock belonging to Fannie and Freddie.

Opponents of the dissolution movement point out that restoring Fannie and Freddie to private autonomy would mean taxpayers would get back their “investment” plus profits, while the housing market would continue on the basis of familiarity. Moreover, it would encourage private competition in the market, and all the general arguments for deregulation would continue to apply.

In short, the entirety of the opposition’s claims rests upon the recent upward trend in Fannie’s and Freddie’s performance.

 

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