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The fate of Fannie and Freddie hangs in the balance

Election results will determine the future of housing as we know it

September 2020, Fannie and Freddie

On the November ballot, you won’t find the names of Fannie Mae and Freddie Mac, the two companies that back about half the outstanding mortgages in the U.S. But the outcome of this year’s presidential election could decide their fates.

Neither party wants to get rid of the companies. What’s up in the air is whether they will be restored to something similar to their prior status as quasi-government entities – meaning, they traded as private companies on the New York Stock Exchange but benefited from an implied government backing – or whether they’ll remain in the hands of the government.

Mark Calabria, the former chief economist for Vice President Mike Pence who was nominated by President Donald Trump in 2018 to become the director of the Federal Housing Finance Agency, has always listed the goal of ending their 12-year conservatorships as one of his top priorities. 

Calabria might push back if you describe it as “privatization,” because they already are private companies that happen to be in conservatorship. It’s just that the government owns 80% of their shares after seizing them in 2008 in the midst of the financial crisis, and controls every facet of their existence. See? 

“Privatize” is a phrase that comes to mind when Republicans are talking about shrinking government’s footprint – the Trump administration has proposed privatizing Medicare, the Department of Veterans Affairs, the U.S. Postal Service and the nation’s roads and bridges. 

So, it’s understandable that people use that term for the plan to release the GSEs from government control. But, in this case, let’s call it a “re-privatization.”

Last year, Calabria and Treasury Secretary Steven Mnuchin released a so-called “roadmap” to re-privatize the mortgage giants. One of the first steps to “recap and release,” as the plans to recapitalize the companies is known, was letting them keep some of their profits. 

In the dozen years since Fannie Mae and Freddie Mac were seized by the government, their profits have repaid the $191 billion in bailouts they received, plus they’ve sent an additional $115 billion to Treasury in what was known as a “sweep.” It left the companies with no capital reserves, completely dependent on the government.

A year ago, Calabria and Mnuchin came to an agreement to let the companies retain up to $45 billion in combined capital.

“The enterprises are leveraged nearly 1,000-to-one, ensuring they would fail during an economic downturn – exposing taxpayers once again,” Calabria said in the announcement. “This letter agreement between Treasury and FHFA, which allows the enterprises to retain capital of up to $45 billion combined, is an important milestone on the path to reform.”

In February, Calabria hired Houlihan Lokey to advise the FHFA on ending the conservatorships with a public offering of the shares held by the government and said Fannie Mae and Freddie Mac would soon be hiring their own advisors. And not even the worst pandemic in more than a century has delayed those plans. 

In June, the CEOs of Fannie Mae and Freddie Mac announced they had chosen their underwriting advisors: Fannie Mae, the bigger of the two GSEs, said it has chosen Morgan Stanley while Freddie Mac said it will use JPMorgan Chase.

So, what’s the rush? A little thing called “election risk,” says Jaret Seiberg, managing director of Cowen Washington Research Group. If former Vice President Joe Biden wins, all those plans may be off the table.

That risk was made worse by a Supreme Court decision in June that put Calabria’s job on the line. The ruling in Seila Law vs. the Consumer Financial Protection Bureau meant both the CFPB and the FHFA director now serve at the pleasure of the president, not as independent regulators appointed to a five-year term who could only be removed “for cause,” meaning negligence or crimes.

“This ruling should ensure that the president can now remove the FHFA director at will,” Seiberg says. “This means election risk is significant for efforts to end the conservatorship as Joe Biden could fire Mark Calabria as FHFA director on Jan. 20 if the Democrat wins the election.”

And, Seiberg said, that may happen because Democrats are less likely to want to re-privatize the companies. Democrats haven’t laid out a plan saying what they would like to do with Fannie Mae and Freddie Mac, but it likely includes more government involvement than the Republicans.

While there’s no concrete plan for the GSEs, which were seized by a Republican administration in 2008, Rep. Maxine Waters, D-Calif., has outlined some principals for housing finance reform.

“It is particularly important to ensure that underserved borrowers and communities are not overlooked,” Waters said. “This means housing finance reform will need to include a comprehensive strategy around access to affordable mortgage credit, as well as access to affordable rental housing.”

Congress chartered the mortgage securitizers to expand access to home loans for average Americans – Fannie Mae in 1938 as part of President Franklin Delano Roosevelt’s New Deal, and Freddie Mac in 1970 as part of legislation approved by a Democratic Congress and signed by President Richard Nixon, a Republican.

They’ve always had the mandate to foster affordable housing. The way the mandate was interpreted is what led to their downfall during the subprime mortgage crisis. 

The main reason for the shaky finances that prompted the takeovers were investments in private-label subprime mortgage bonds, containing loans that didn’t qualify to be backed by the two companies but were bought – once they had been packaged into bonds by Wall Street and sold to investors on the open market – as a backdoor way to fulfill their affordable-housing Congressional mandate.

At the time, Wall Street was making money hand-over-fist packaging risky loans – the type Fannie Mae and Freddie Mac don’t guarantee – into bonds and selling them on the open market trumpeting their the highest Triple A rating from companies like Moody’s and Fitch, who were paid for giving their approval.

The problem was: Many of these subprime mortgages were given out on the premise that home prices would continue rising, and the risky borrowers could improve their credit with on-time payments and refinance before some of the more onerous provisions of their loans kicked in. 

For example, a popular subprime product was an “exploding ARM,” meaning an adjustable-rate mortgage that had a super-low teaser rate that would more than triple in two years. 

There was a housing boom going on the first half of the 2000s, which every major housing forecaster predicted would lead to a “soft landing” – meaning, home-price growth would slow down for a period of a few years to balance out the market. 

It might have happened that way, if it were for the widespread subprime lending – what one market-watcher called “a monster under the water.”

When the risky loans began defaulting at the end of 2007, that soft landing turned into a housing crash, bringing down not just the value of subprime bonds and the houses they financed, but the safer securities such as those packaged by the GSEs as well, along with the whole housing market.

All the Wall Street executives got to keep their fat bonuses bestowed during the run-up to the crash, and many got additional bonuses even while firms like Lehman Brothers and Bear Stearns toppled and the economy crashed. 

But the housing market was broken. While there had been regional housing crashes in recent decades, it was the first time since the Great Depression the national market crashed.

Prior to Fannie Mae’s creation by Congress during the Great Depression, someone who wanted to buy a home had to pass the muster of local banks who knew they would be holding the mortgage, and the risk, for the life of the loan.

With Fannie Mae, bankers could make loans that met the conservative – but not ultra-conservative – standards set by the government and sell them to Fannie Mae to be packaged into mortgage bonds that were sold to private investors. 

That off-loading of risk created a liquid mortgage market that former Federal Reserve Chairman Alan Greenspan and others would later call “the envy of the world.”

So, while the collapse of the financial system in 2008 was caused by subprime mortgages that didn’t meet Fannie Mae and Freddie Mac standards, the GSEs got swept into the debacle. To this day, many in Congress blame them for the financial crisis, even though they had been given the nod by regulators to add subprime bonds to their investment portfolios as a way to meet the affordable-housing mandate given to them by Congress.

After subprime defaults caused a panic on Wall Street and toppled major banks such as Washington Mutual, once one of the nation’s largest lenders, the damage spread throughout the economy and soon the “vanilla mortgages,” as GSE-backed loans are sometimes called, went bad too as borrowers lost their jobs and couldn’t pay their bills.

President George W. Bush, a Republican, made the decision to seize the companies in an effort to stabilize the housing market amid the chaos of the mortgage meltdown. Henry Paulson, then Treasury secretary, made a colorful pledge to Congress in July 2008 when he was lobbying for the bailout of Fannie Mae and Freddie Mac.

Paulson told lawmakers that giving him authority to rescue the firms would reassure private investors, resulting in the government not having to take full control of the companies.

“If you have a bazooka in your pocket and people know it, you probably won’t have to use it,” Paulson said at the time.

It turned out he was wrong. He got the power to seize the companies, and less than two months later they were placed in government conservatorship. That November, Barack Obama won the election to be the next president.

In 2009, Obama pledged to back the beleaguered mortgage financiers no matter how big their losses might be in the next three years. As the housing market began a slow recovery, Fannie Mae and Freddie Mac became profitable again as they packaged and sold those mortgages.

Now, the Trump campaign hasn’t spoken much about housing issues, he has however, shown over the past 3.5 years how he approaches the industry. For example, at the beginning of his presidency, Trump signed an executive order, mandating that two regulations must be eliminated for every regulation created. He has also ended several Obama-era regulations such as certain fair housing regulations. 

To date, 860 regulatory actions have been withdrawn or removed from active status under Trump’s presidency. Under his watch, regulators have taken a smaller role and the government has taken a more hands-off approach to the housing industry. 

The Biden campaign, on the other hand, proposed a $640 billion housing plan in February it said would improve affordability, end discrimination and protect consumers. The campaign mentioned Fannie Mae and Freddie Mac as part of those proposals, suggesting an increase in fees for GSE mortgages as a way to fund spending on affordable housing. 

“Biden will increase the availability of affordable housing through the Housing Trust Fund, paid for by an increase in the assessment on Fannie Mae and Freddie Mac,” the plan says. “These additional dollars will support the construction and rehabilitation of affordable housing units.”

Biden also proposed tax incentives to encourage the building of affordable housing, and a national “Homeowner and Renter Bill of Rights” modeled on the California Homeowner Bill of Rights that the campaign said is aimed at protecting people from abusive lenders and landlords.

If Trump is the winner in November’s election, it’s likely Calabria will remain as FHFA director and Fannie Mae and Freddie Mac will be released from government conservatorship next year in a share offering that would set a record as the largest in history: Analysts have valued the offering between $150 billion and $200 billion. 

In comparison, the largest IPO in history was Saudi Aramco, the Saudi Arabian government’s petroleum and natural gas company. It raised $25.6 billion last year, beating Alibaba’s $25 billion IPO in 2014.

For the record, offering shares of Fannie Mae and Freddie Mac technically wouldn’t be “initial public offerings,” because Fannie Mae began trading on the New York Stock Exchange in 1968, and Freddie Mac began trading on the same exchange in 1989.

The “offering” would be the 80% of Fannie Mae and Freddie Mac held by the federal government since 2008.

Shares of the companies once traded above $68 and were considered as safe as U.S. Treasuries because of an implied government backing. They were kicked off the NYSE after their government takeovers and became penny stocks. In November 2008, you could have bought a share of Fannie Mae for 54 cents. Today, it would cost around $2.

If Biden is elected, Calabria may be searching for a new job, and the re-privatization of Fannie Mae and Freddie Mac likely will be off the table. 

The GSEs will still be the two dominant players in the U.S. housing finance system, but it’s likely to be the government, and not private shareholders, calling the shots.

To read the full issue of HousingWire Magazine, click here.

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