Are The Days Numbered for Fannie Mae and Freddie Mac?
There’s no question that there are major problems at Fannie Mae and Freddie Mac. But the Obama Administration is about to throw the baby out with the bath water.
Fannie and Freddie are both government-sponsored enterprises (GSEs) created to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS). Fannie and Freddie purchase pools of securitized mortgages from institutional lenders as well as local banks. This allows for more banks to lend in the mortgage market and for lenders to reinvest their assets into more lending. The system creates liquidity in the housing market, providing banks with more money to finance more home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.
Fannie Mae has performed this task since 1938 and Freddie Mac since 1970. Fannie and Freddie currently have their hands in the majority of mortgages throughout the United States to the tune of over ten trillion dollars. And the system has worked well for decades.
Last year, the Democrat controlled Congress passed the Frank-Dodd Financial Reform Act. The law tried to address problems in financial industries Congress does not understand with “solutions” that don’t address the real causes, thereby exacerbating the real problems. Ironically, Frank-Dodd did nothing to address the elephant in the room: the problems at Fannie and Freddie.
Right now there’s a huge rumbling going on about getting rid of Fannie and Freddie. President Obama recently released a number of prospective plans for eliminating these two GSEs. If implemented, these plans would completely change the process of mortgage lending as we know it. They call for privatizing the process, requiring lenders and investors to fund new mortgages, with the government only stepping in to help the underserved, the poor, and veterans.
At first, this might sound like a good idea. I’m typically a proponent of having the government less involved in businesses and the economy. But consider this: The implicit guarantee and thus stability that the government currently provides through Fannie and Freddie allow for lenders to offer lower interest rates than if Fannie and Freddie didn’t exist. If we privatize the rolls that FNMA and FHLMC currently occupy we are left with Private-Label Securitization – the major conduit for the sub-prime lending that greatly contributed to this mess we’re in.
Privatization will lead to more risk for mortgage lenders. It should be blatantly obvious that after the past five years of lender implosions, borrower defaults, and bank losses, lenders across the country are hyper-sensitive to risk. Yet despite this aversion to risk, lenders are still lending. If we get rid of the government’s implicit guarantee with Fannie and Freddie, the increased perception of risk could lead to:
- A drastic reduction in mortgage lending
- The elimination of long term fixed rate products
- Higher interest rates to the consumer
- Higher fees charged by lenders to the consumer
There’s no doubt that a cure is needed for what ails Fannie Mae and Freddie Mac. But is it necessary to scrap them altogether? When you think of the enormity of the task the Obama Administration is trying to tackle, caution is warranted. Before they try to fix the problem, the Obama Administration had better be sure they first understand the true causes.
(Inspired by the TBWS Daily Show, 2/17/11.)
Warren Goldberg is a Mortgage Planner and published author. His interviews include Blog-Talk Radio, Newsday, and the Long Island Herald. His newsletter is read by almost two thousand subscribers.
Since 1992, Warren Goldberg has helped thousands of clients own their homes, refinance their mortgages, restructure their debts, and invest in real estate. Warren is known for his wide knowledge of mortgage products and wealth-creation strategies.