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President Obama announced Tuesday the time has come to “wind down” Fannie Mae and Freddie Mac, backing a Senate bill to replace them with a smaller, similarly Federally backed, mortgage underwriter—potentially making room for more private firms in mortgage financing. Some posit this will cause interest rates to rise, making homes less affordable and choking housing’s recovery. But we’d suggest shifting the lion’s share of mortgage underwriting to the private sector would give homebuyers more competitive financing options—a positive for housing markets and the broader economy. However, the likelihood this legislation passes in its present form seems slim—it’s premature to get hung up on the plan’s potential plusses and minuses.
For ages, Fannie and Freddie have essentially monopolized mortgage underwriting. Though technically private firms, they were sponsored and implicitly (and since nationalization, explicitly) guaranteed by the government, which allowed them be a bit less judicious about underwriting decisions than a fully private firm might be. Other firms largely couldn’t compete. Since they were nationalized in 2008, they’ve guaranteed about 90% of all mortgages.
The proposed plan would replace Fannie and Freddie with a new agency, the Federal Mortgage Insurance Corporation, which would underwrite a much smaller percentage of mortgages—private firms would fill most of the shortfall. This would effectively remove the government’s guarantee of most of the housing market. Some suggest this means borrowing costs will rise, since private firms—which lack a government backstop—must apply higher standards. And there is some truth to this, philosophically. But opening the market to new players would also increase competition in mortgage underwriting, which would likely help keep mortgage rates in check. Perhaps firms will get more creative with securitization, devising new ways to help mitigate risk. This might raise some eyebrows among those who deem securitized debt responsible for 2008, but overall and on average, securitization and other derivatives help prevent risk from concentrating in one area of the financial system.
On the whole, the proposed change would likely be a long-term positive—whether Congress passes it is another matter entirely. Congress is gridlocked. Really gridlocked. So gridlocked, in fact, the 113th US Congress has earned a reputation as the most inefficient Congress ever. They’ve passed a whopping 22 laws all year, including measures to rename monuments and create commemorative coins. None are of consequence, save for a couple 11th-hour fiscal cliff and sequestration-related bills.
No such urgency surrounds Fannie and Freddie, which sets the stage for politicking and delays. Compounding matters, the House has tabled a competing bill, which also proposes winding down Fannie and Freddie but proffers no replacement—instead, it advocates removing government involvement altogether. That’s a pretty big discrepancy and likely very difficult to overcome. The chances either the House or Senate makes a full swing to the other’s bill are slim to none. More likely, gridlock leads to watered-down legislation, if something passes at all—and amendments introduced during debate could alter the landscape and create unintended consequences.
So if Congress can come together and pass a bill, given the many unknowns, it’s simply too soon to gauge whether it would benefit markets. However, the proposed five-year timeline for full implementation (should it stand) likely limits the near-term market impact, good or bad. Five years is a long time for markets to digest the new reality. It’s also a big window for this or a future Congress to make further changes. And investors in the here and now can’t game what those changes might look like—too many unknown variables exist. Legislation looking this far ahead likely has little near-term impact.