Both Fanny and Freddie incurred billions in financial losses during the subprime mortgage crisis that began for them in 2007. In order to ensure they remained in operation and solvent, they were taken under US government control or conservatorship. The question at hand is how and when to end this conservatorship. I met recently to discuss the issue of housing finance reform with Lindsay Johnson, President of US Mortgage Insurers.
The State of the State
For over 11 years, Fanny Mae and Freddie Mac have been under the control of the Federal Housing Finance Agency (FHFA). Both entities entered into agreements under which they were each provided with over $200 billion in treasury support. As Johnson points out, GSEs have grown in both size and market dominance since being taken under FHFA control in 2008. Today, the GSEs guarantee more than $5.5 trillion of the US mortgage market, but each maintains a very low capital cushion, in part because under the conservatorship agreement, their profits are sent to the US Treasury. “The FHFA is now allowing [Fannie Mae and Freddie Mac] to retain a little bit more of that cushion, but it’s still nominal compared to their overall exposure.” FHFA Director Mark Calabria hopes to increase the capital standing of the GSEs so they are better prepared in the event of any future financial crisis. Since becoming FHFA in mid-2019, Calabria has been explicit about his intent to get the GSEs out of conservatorship.
The Guarantee Question
One of the biggest issues with the GSEs is that they do not operate with an explicit government guarantee of credit worthiness. However, lenders have historically granted that this kind of guarantee is implicit. Prior to the 2008 Financial Crisis, says Johnson, “there was this perception that the government had their backing, despite the fact that their debt was explicitly not backed by the federal government.” Yet as the crisis unfolded, the government deemed the GSEs too systemic to allow to fail and stepped in to protect them. “I think all stakeholders would now agree,” Johnson remarks, “that it would be important to have an explicit and paid-for guarantee on mortgage securities, not necessarily [Fannie Mae and Freddie Mac].”
Both Republican and Democratic legislators have found it challenging to reach any consensus within their own parties on the issues and challenges facing the GSEs. This is in part because, as Johnson describes, each party has its own varying “ideologies about the role of the federal government [and the] social policies of housing.” Generally speaking, in order to amply increase their capital cushion and operate with credit guarantee, the GSEs would like have charge more, which would likely increasing housing prices and further complicate the availability of affordable housing nationwide.
Potential Market Implications
As Johnson notes, the broader market implications of GSE reform will take shape as the post-conservatorship form of Fannie Mae and Freddie Mac becomes more clear. Will the GSEs again become publicly traded companies as they were prior to the Financial Crisis? Will they become private companies? Or will they operate more as highly-regulated utility-like entities? According to Johnson, “There’s a lot of ‘if-then’s’ that we’re going to have to face as we move down this road.”
The Road Home
Johnson says Trump administration officials have expressed an interest in more competition and transparency in housing finance. Meeting these goals and reaching an agreement on how to end the GSEs conservatorship will require legislative action from Congress. New legislation on the issue is unlikely to be passed in an election year. While GSE reform is a challenging and complicated issue, Johnson remains optimistic that a solution can eventually be reached that works for homeowners, stakeholders, and investors alike.
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