In August, 2013, President Obama and Congress formalized their desire to dismantle the mortgage giants, Fannie Mae (FNMA) and Freddie Mac (FHLMC).
Both FNMA and FHLMC have been blamed in part for causing the 2008 financial meltdown and subsequent Great Recession, from which the United States is still struggling to recover. There are a great many reasons for the financial meltdown. While Fannie and Freddie are far from blameless, they’ve been political scapegoats while other more culpable entities, including two presidential administrations, Congress, and many of our nation’s monolithic banking institutions, have skirted taking any responsibility. (For a full analysis and explanation for the financial meltdown, read SECURITIZATION: How our society changed when we learned to turn lead into gold.)
Fannie and Freddie are the two government created yet private corporations responsible for maintaining liquidity in the mortgage markets. Freddie Mac has performed profitably and effectively since it was created in 1970, while Fannie Mae has done the same since 1938! For over 70 years, these institutions have been cornerstones to our housing market, functioning profitably for their shareholders and maintaining liquidity for over three generations of homebuyers! Why then do the President and Congress believe we should tear down the infrastructure for the entire housing market and start from scratch? A clear explanation must begin with explaining why FNMA and FHLMC are integral to the housing industry and the economy as a whole.
Since their creation, both Fannie Mae and Freddie Mac have been tasked with purchasing loans from lenders throughout the United States. Banks can only lend money they have available on their books. Banks are also required to maintain a certain amount of liquidity (lest there be no funds available when you cash a check or make a withdrawal). Therefore, lending institutions only have a finite amount of money to lend for mortgages, business loans, car loans, etc. With institutions such as Fannie and Freddie, banks now sell their loans to FNMA and FHLMC in order to replenish their coffers. Both Fannie and Freddie package these loans into investment pools called Collateralized Mortgage Obligations (imagine mutual funds of mortgages instead of stocks or bonds) and then sell these to investors on Wall Street. When shares of these investments are purchased, both Fannie’s and Freddie’s funds are replenished so they may purchase more loans from the banks. And the cycle continues.
In order to ensure the relative safety, stability, and attractiveness of these investment vehicles, the federal government insures the principal on these investments. This insurance is paid for via “Guarantee Fees” (or G-Fees) which are charged to banks (and of course passed on to borrowers) on every loan sold to Fannie or Freddie. As mentioned, the system has worked safely and effectively for over 70 years.
Both Fannie and Freddie maintain liquidity in the mortgage market, thus also keeping mortgage rates reasonably low. Without Fannie and Freddie, mortgage lending would be limited to the finite funds lenders have available. The limited supply of money and high demand for loans would drive rates through the roof and drive lenders to pick and choose only the best qualified borrowers and most profitable loans to lend. In addition, since most portfolio lenders base mortgage rates in part on their own varying costs for money, the 30 Year Fixed loan – a staple in the housing market – would all but disappear, forcing borrowers to accept short-term or variable rate mortgages. Think this is far-fetched? Peer into the commercial mortgage arena. Most commercial mortgages are 5-7 year adjustables, with 15 year terms the norm. Want more proof? Where else in the world can you find a 30 year fixed rate residential mortgage? You’ll be hard-pressed to find many.
The taxpayer’s bailout of Fannie and Freddie were the result of a perfect storm, a snowball created by a government mandate that picked up mass and speed as it rolled downhill until it ultimately crashed causing the destruction we’ve all witnessed. (Read SECURITIZATION: How our society changed when we learned to turn lead into gold for an expanded analysis.) However, since their bailout, both Fannie and Freddie have generated record profits, returning to the US Treasury virtually all of the $187-billion they received. (Unfortunately, as part of Fannie’s and Freddie’s deconstruction, the federal government now requires all profits be swept to the US Treasury and be considered “interest payments” rather than repayments of principal, thereby ensuring the “principal” will never be repaid.)
In a rare instance of bipartisanship, both Congress and the White House are working towards the demise of Fannie Mae and Freddie Mac. How seemingly no one involved in these deliberations has a deep understanding of the intricacies of our housing industry is indeed ironic. It’s the blind leading the blind, if you will.
Fannie Mae and Freddie Mac have proven their value for decades. While they could certainly use some tweaking in order to prevent a future real estate implosion, eliminating Fannie and Freddie altogether would be like throwing out the baby with the bathwater. Lastly, the catastrophic government insurance the industry currently enjoys, paid by lenders and borrowers via G-Fees rather than by the tax payers, benefits borrowers, the lending industry, the economy, and taxpayers alike. If it is eliminated, I fear the housing market may look very different in a few years.
Warren Goldberg is President of Mortgage Wealth Advisors, a Certified Mortgage Planning Specialist®, and a published author. His interviews include Blog-Talk Radio, Newsday, and the Long Island Herald. Since 1992, he’s been sharing his financial knowledge and wealth-building strategies, including how to properly use your mortgage as a financial tool. His clients regularly express their trust and appreciation by recommending friends and family call when in need of mortgage, real estate, and financial guidance.