Debate grows over Fannie and Freddie securities guarantee

Could the flow of mortgage financing continue without a backstop?

Debate grows over Fannie and Freddie securities guarantee

What does Brexit have in common with the privatization of Fannie Mae and Freddie Mac?

A whole lotta concern about a backstop.

In the case of Fannie and Freddie, that concern centers around the government failing to provide an explicit backstop of the $4.7 trillion worth of mortgage securities that the entities currently hold.

Although financiers and lawmakers alike have made the case to release Fannie and Freddie from conservatorship along with broader finance reforms, the rush to do so has credit ratings companies, financial firms, real estate agents and even astute citizens wary.

Fannie and Freddie are pillars of the housing industry, buying mortgage loans from lenders, and packaging that debt into securities. If there is no backstop as a clear guarantee of Fannie and Freddie’s securities, large asset managers could scale back their bond buying out of fear that they could lose their interest and principal, Bloomberg reports. That restraint could stem the flow of financing, making it more difficult—and more expensive—for consumers to get a mortgage because mortgage rates would likely rise and credit might become less available to home buyers.

Even though it’s a concern on the minds of many, that’s not translating to bond prices. Those remain unchanged, and of course, mortgage rates remain low.

Michael Bright, president of the Structured Finance Industry Group and the former acting president of Ginnie Mae, told Bloomberg that keeping Fannie and Freddie structured exactly as they are and releasing them to privatization is a “dangerous experiment.”

The National Association of Realtors also supports an explicit government guarantee. NAR President John Smaby penned a letter to Federal Housing Finance Agency Director Mark Calabria, stating that any reforms must be well designed and thoroughly vetted before implementation. He also added that any reforms should take place keeping in mind the public mission of the GSEs.

“A curtailed or eliminated guarantee could raise costs and threaten access to credit in small and mid-sized towns when recessions or natural disasters hit. Dilution of the mission will also affect middle income homebuyers and underserved markets, exacerbating the lingering impacts of the subprime crisis on inequalities in homeownership,” Smaby wrote.

Calabria has said that he has not formally asked lawmakers to provide a guarantee, but if they do, it should be limited, instead saying that Fannie and Freddie could weather another economic downturn by building up their capital buffers and reducing market risk, something which Treasury Secretary Steve Mnuchin also supports. Congress is the only party that can provide a guarantee, and although Mnuchin has said that he would prefer a backstop, he’s also open to the idea of bypassing Congress altogether to end Fannie and Freddie’s conservatorship.

While Fannie and Freddie have been in conservatorship, the assumption has been that they’re completely backed by the U.S. government. If the companies suffer losses, they can draw on $258 billion from the Treasury. Those billions of dollars could help mitigate the need for an explicit guarantee of mortgage securities, but only if the funds remained available to Fannie and Freddie upon privatization.