Eileen's Blog

Our World Without Fannie or Freddie

March 16th, 2011 10:22 AM by Eileen Denhard

Our World Without Fannie or Freddie

 know that the title sounds strange to suggest such an action, especially right now. However, that is actually what President Obama recently mentioned. Now, whether or not this is doable is a completely different story.

Currently, nine out of ten home loans originated right now is purchased by one of the two behemoths, which are officially titled Government Sponsored Enterprises, or GSEs. They package them in pools of loans of similar characteristics, slice them into tranches, and sell them in the secondary market, thereby recycling the dollars to replenish the process. However, conversations are occurring around Washington D.C. that the two largest purchasers of home mortgages and apartment loans (5+ units) will be slowly phased out to reduce the people’s dependency on the government for the facilitation of the mortgage market. Given that the American mortgage market has over $10.5 trillion in outstanding balances, this will be no small feat. I predict that the debates will be long, fiery, and quite contentious as the determination of the government’s role in ongoing mortgage liquidity and its effect on the financial markets around the world will certainly lead to a variety of opinions from Main Street, Wall Street, and Pennsylvania Avenue.

Can you begin to imagine a world without Fannie Mae or Freddie Mac? That is not even fathomable at the present time. The only other purveyors of capital are the Federal Housing Agency (FHA) and private money, also known as hard money. If the FHA goes down the same path, can you think of the effect that it will have on the mortgage market for capital? Certainly, there will be an increase in costs that will occur for all borrowers for homes and apartments. There will be initial trepidation in the market to purchase mortgage paper without an explicit or implicit government guarantee. However, it can be done and in the past had been done. Yes, we are currently in the middle of a mortgage “mess” as Treasury Seretary Geithner would say, but there was a time when Fannie and Freddie were barely mentioned. Once upon a time when investment banks, hedge funds, insurance companies, stock brokerage houses, and private equity funds participated in the mortgage market, the GSEs took a serious back seat to the competition. The self employed and the real estate investor were obvious examples of non-GSE mortgage customers, but also Main Street borrowers as well. In many cases, if the only difference between a Fannie/Freddie loan and a stated loan from an Alt-A lender was a .25% higher rate, a borrower would take the higher rate to avoid the documentation hassles. The problems arose when the too many people traded the rate for documentation or a lack thereof.

As such, the Obama administration’s latest barrage necessitates that private label financing will make a serious come back. Mr. Geithner has said that he wants to “crowd private capital back in.” So expect that over time a few things will change to move more people towards private label financing and away from Fannie/Freddie funds. Fees that will be charged to obtain a GSE loan won’t be charged on private label financing. Loan limits will fall for GSE financing requiring higher down payments. GSE financing will charge for the quasi-Federal guarantee; once again making private label money the preferential choice. This has already occurred with the FHA. It is the lender of last resort not because of a popularity contest, but due to forced mortgage insurance, tax impounds and upfront MIP fees. The idea that you will pay for a Fannie/Freddie loan is not far fetched at all. Accordingly, cost-conscious consumers when faced with two alternatives will choose the cheaper one if they can qualify.

Therefore, we should anticipate a weaning off of government life support for the mortgage market, not in the immediate, but the not to distant future. For now, we obviously need the GSEs to prop up the US housing market and maintain a clearinghouse for the recycling of mortgage dollars. However, as the market stabilizes, anticipate that the Federal government will take a huge step back, which will require the mortgage market to stand on its own two feet. The pent up demand will definitely be there as users of mortgage capital will hate the increased costs, fees, and requirements to obtain GSE financing. I do believe that rewards and incentives will have to be in place to get private labels to re-enter the marketplace, but once they do many people will be singing “happy days are here again.” Hopefully, things won’t get too out of control. We shall see.

Posted in:General
Posted by Eileen Denhard on March 16th, 2011 10:22 AM

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