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Moody's predicts little GSE reform in the next few years

Fannie and Freddie ratings will move in lockstep to sovereign

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A report released from the main government-sponsored enterprise analyst at Moody's Investors Service, Brian Harris, casts doubt on the possibility of meaningful reform at Fannie Mae and Freddie Mac in the next few years.

Harris also outlines three steps the Federal Housing Finance Agency, the GSE oversight body, under-uses to attempt to reduce the footprint of Fannie and Freddie in the mortgage market and the reasons why.

The FHFA remains committed to reducing the GSE footprint, but is doing so only little by little. The three-pronged approach includes private risk-sharing deals, increasing guarantee fees and reducing the conforming loan limit. As the three linked articles point out, there are pros and cons to each.

There does remain a more accelerated reform avenue via legislation, but as Harris points out, there remain political headwinds to this.

"Some of the obstacles to reform have been removed by the improving housing market and the return of the GSEs to profitability over the last several quarters," said Harris. "But this doesn’t clear the main roadblock to GSE reform, which is Congress’ disparate views of the role of the US government in housing."

Cade Holleman, who works in government relations at the American Legal & Financial Network, a national network of legal and residential mortgage banking professionals, wrote a column on GSE reform for the next issue of HousingWire magazine.

According to Holleman, it's a patchwork of political efforts to push party views on housing policy, which differ immensely.

"The new system and regulatory framework must acknowledge the securitization process as part of the modern mortgage wheelhouse and create viable oversight mechanisms with clear lines of authority for where structured finance and housing finance intersect," reads his upcoming article in the December issue of HousingWire magazine.  "Both chambers of Congress have presented plans to achieve a mix of these goals, shedding light on the next incarnation of America’s housing finance."

Holleman's comments indicate that GSE reform needs to hold an endgame for the private capital markets. The $10 trillion capital market for U.S. mortgages, after all, represents the second largest fixed-income market in the world, after Treasurys.

The current legislation may fail to fully appreciate the nuances of such a large and complex operations.

"One of the challenges with the current legislation is its focus on the end state for the mortgage market rather than how to go from the current state to that end state. The process of how we would get from here to the end state is critical given the importance housing finance in the US economy," said Harris.

"Private capital is available in the mortgage market but it must compete with the GSEs who have a distinct cost advantage in that they issue debt at yields very close to Treasury yields," he added.

The final point is compelling because it exemplifies the intertwined nature of the GSEs to the sovereign. As a result, Moody's ratings on Fannie and Freddie senior debt (Aaa ) and subordinated debt (Aa2), are likely to move in lock-step with the U.S. sovereign rating. This could become an issue further on as debt-ceiling negotiations return in February. At any rate, this risk to Fannie and Freddie's rating is unlikely to motivate legislators to push to extract the government from the mortgage market in the foreseeable future.

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