After over a decade of stagnation, the race is finally on to release mortgage giants Fannie Mae and Freddie Mac from government control and reshape the housing finance system.
The devil is, as always, in the details — except that some of the “details” aren’t so limited in scope. One of the biggest questions in play right now revolves around the question of whether Fannie and Freddie will continue to operate as a duopoly. It’s a question with enormous implications: trillions of dollars of business for industry participants, and access to the American Dream for ordinary households.
As a brief reminder, the two companies were chartered by Congress decades ago to provide liquidity to the U.S. mortgage market. Fannie
don’t make mortgages, but buy the ones that lenders extend to borrowers, helping free up more capacity for the banks to go out and lend more.
During the housing bubble of the early 2000s, the two competed with all kinds of private-sector mortgage players. They extended too much, and too-risky, credit, leading to a liquidity crisis. As the financial system melted down in 2008, they were rushed into government control.
That’s where they’ve remained, until now, as Congress has failed to find a permanent solution for how to release them, and for what the future housing finance system should look like.
The current state of affairs is troubling for a few reasons. The two companies currently guarantee about 45% of all new mortgages, according to data compiled by the Urban Institute. They have almost no capital buffers, as a result of a strange experiment from legislators who tried to force themselves into taking action on the matter. And no one has any idea whether the future state will look a lot like the current one, or be drastically different.
Right now, most housing-watchers are focused on one idea in particular. It was mentioned in a report filed by the two enterprises’ regulator, the Federal Housing Finance Agency, last week.
“The Enterprises’ current duopoly undercuts competition in the market,” said FHFA director Mark Calabria in the regulator’s annual report to Congress. “Increased competition would reduce market reliance on either Enterprise and enhance market stability, as well as benefit home buyers. To promote competition, Congress should authorize additional competitors and provide FHFA chartering authority similar to that of the Office of the Comptroller of the Currency.”
That idea isn’t new. It’s been contemplated ever since the two have been in conservatorship, and expressed more explicitly as a goal in a memo from the White House to the Treasury Department in March.
And it is important to note that it’s highly unlikely Congress will make any motion toward housing finance reform of any kind, least of all something as weighty as allowing a regulatory agency to charter a private company alongside Fannie and Freddie, with the ability to guarantee millions of mortgages, possibly with some implied government support in doing it.
(Some background on why Congress is unlikely to take a leadership role in any reform efforts can be found here: Fannie-Freddie reform could rewrite a familiar Washington script)
As Washington analyst Isaac Boltansky put it in a note in March, “the multi-guarantor construct was repeatedly and methodically criticized throughout the two-day Senate Banking Committee hearing, which underscores the political and practical headwinds it faces; (2) granting new chartering authority would take Congressional action, which remains highly unlikely in the near-term; and (3) even with chartering authority, regulatory and market considerations could dampen interest in forming a new guarantor.”
So far, no company has publicly stated that they want to be a competitor to Fannie and Freddie in guaranteeing mortgages.
The credit rating agency Moody’s had this to say about the Calabria request:
Moody’s stated: “A severe reduction in either companies’ market share would reduce their centrality to the U.S. housing finance market. A materially lower market share would erode the creditworthiness of the two companies and could lead us to reduce our support assumptions for Fannie and Freddie. In addition, more competitors could lead to weaker underwriting standards or price competition, both credit negatives for the GSEs’ creditors.”
That’s essentially what happened during the bubble, when the two companies chased each other — and private lenders — to the bottom in a race for market share. It stands to reason that most housing finance participants would want to avoid such an outcome now.
Housing advocates are watching this issue closely.
“The new guarantors would have little oversight over whether they use the guarantee to further the public interest and make responsible homeownership and affordable rental housing accessible to the full market,” said Mike Calhoun, president of the Center for Responsible Lending, in testimony to Congress in March.
“Most important, the strong incentives for multi-guarantors to maximize revenue would invariably lead to targeting the most lucrative housing markets and the largest, most profitable lenders,” he added.
Earlier coverage: Congress wouldn’t do it, so Fannie and Freddie reformed themselves