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What to do about Fannie & Freddie? How the Trump administration could change the mortgage industry

by Chip Bell

The Mnuchin imperative

Those questions will be among the most pressing that the incoming Trump administration will have to answer – and the answers have changed, over time.

Steve Mnuchin, Trump’s treasury secretary pick, originally signaled that the days of Fannie and Freddie’s conservatorship were numbered.

“It makes no sense that (Fannie Mae and Freddie Mac) are owned by the government and have been controlled by the government for as long as they have,” Mnuchin said during a Dec. 2016 interview on the FOX Business Network’s “Mornings with Maria.” He further promised to separate the GSEs from the government “reasonably fast,” if he is confirmed as treasury secretary.

Mnuchin blamed the conservatorship for displacing private lending in mortgage markets, despite the fact that since 1990, the only time private mortgage insurers held a more significant market share than Fannie and Freddie was in the years immediately leading up to and during the 2007 mortgage crisis. Otherwise, Fannie and Freddie have always insured the overwhelming bulk of residential mortgages.

However, Mnuchin’s position was decidedly different during his recent Senate confirmation hearing. When questioned about how the Trump administration was planning to handle Fannie and Freddie, he claimed that he had never been supportive of a “recap and release” for the GSEs. Instead, he clarified, “what I’ve committed to is that I will work with both the Democrats and Republicans. We need housing reform, so we shouldn’t just leave Fannie and Freddie as-is for the next four or eight years under government control without a fix.”

But the momentum Mnuchin’s December interview gave to removing Fannie and Freddie from conservatorship may be hard to reverse, as it has long been a point of policy for Congressional Republicans, and is even supported by FHFA Director Mel Watt.

In remarks Watt made early in 2016 at the Bipartisan Policy Center in Washington, D.C., he said: “I have consistently stated that our responsibility and role at FHFA as conservator is to manage in the present. However, as we work to appropriately manage challenges and risks in the present, we also have a responsibility to assess when these challenges and risks may escalate to the point that they negatively impact the Enterprises and the broader housing finance market in the future. By giving this speech today, I am signaling my belief that some of the challenges and risks we are managing are escalating and will continue to do so the longer the Enterprises remain in conservatorship.”
It is unclear, though, in what capacity Watt would prefer Fannie and Freddie to operate post conservatorship.

A case for re-privatization

Tim Brigham is an LPO manager with Chicago-based Evolve Bank and Trust. To put the possible ramifications of once again privatizing Fannie Mae and Freddie Mac in perspective, he looks to other private institutions already operating in the mortgage market.

“Privatization of loans has had great success with some of the portfolio lenders out there,” Brigham says. “We call them portfolio loans, which means a bank uses its own funds for a deal and they are backed by the bank’s investors. In most cases, that allows the banks to write their own rules on risk while still adhering to industry standards for protection of the consumer.”

The key detail in Brigham’s statement is that a portfolio lender “uses its own funds.” It has its own capital reserves to draw from. So in the case of a down quarter, or a down year, when cash outflow exceeds inflow, the bank can draw on those reserves to stay afloat. Fannie and Freddie do not operate that way – they rely on the Treasury Department for funds.

The two GSEs currently have a built-in store of cash called a “capital buffer,” which is meant to act as a reserve in the event of a loss. But as Watt explained in his Bipartisan Policy Center address, that buffer is being systemically removed.

“(The) capital buffer is available to absorb potential losses, which reduces the need for the Enterprise to draw additional funding from the Treasury Department,” Watt said. “However, based on the terms of the (preferred stock purchase agreements), the capital buffer is reducing each year. And, we are now over halfway down a five-year path toward eliminating the buffer completely.”

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