The recently renewed push to privatize mortgage enterprises Freddie Mac and Fannie Mae could spur … [+]
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The recent renewal of efforts to release government-backed mortgage buyers Freddie Mac and Fannie Mae from federal oversight could change the mortgage landscape for American borrowers, if the process is successful.
The privatization proposal released by Mark Calabria, director of the Federal Housing Finance Agency, which oversees the two enterprises, follows an earlier plan introduced by his predecessor in 2018.
“Together, the enhancements in the re-proposal ensure each Enterprise’s safety and soundness and its ability to fulfill its statutory mission across the economic cycle, in particular during periods of financial stress,” Calabria said in a statement.
While the proposal still has a long way to go – from receiving public comments to weathering a potential political turnover – before it is implemented, its current framework of substantial capital reserves and various risk buffers, among other requirements, is already anticipated to impact mortgage borrowers.
Higher interest rates and loan fees
Under the scrutiny of the government, Freddie Mac and Fannie Mae hold less capital than banks do. Because of their conservatorship, the two entities also borrow from the U.S. Treasury at rates lower than what is available to banks.
The privatization proposal would compel Freddie Mac and Fannie Mae to raise roughly $240 billion in order to achieve an “equal footing,” with other financial institutions, says Holden Lewis, home and mortgage expert at NerdWallet, a personal finance company.
At the same time, however, unlike most mortgage lenders, the enterprises hold a single asset – the mortgages they purchase from lenders and securitize for investors. In the event that Freddie Mac and Fannie Mae exit federal oversight, their focus on a singular financial product could expose them to a heightened risk.
“They have two levers to control their risk: either by increasing pricing or by tightening their underwriting,” says Lewis.
The result would be, economists seem to agree, higher loan fees and higher interest rates – at least by a quarter of a percent.
“This is just not something that is going to cripple the housing market,” says Lewis. “I think it would be a fairly modest effect.”
Yet, Moody’s Analytics Chief Economist Mark Zandi says that would the privatization happen, the increase in mortgage rates is to impact borrowers differently depending on their credit scores.
“For the typical borrower in the middle of the credit distribution, in a typical economy, [rates] would go up more or less depending on whether you’re a good or bad borrower, or a better or worse credit risk [for lenders], depending on where you are in the business cycle,” Zandi says.
Often the usual high-risk borrowers are first-time homebuyers, who, in many instances, have been locked out of the housing market due to chronically tight inventory that has pushed home prices upward for years.
[First-time homebuyers] are a segment of the market that U.S. policy has always wanted to help,” says Michael Fratantoni, chief economist at the Mortgage Bankers Association. “It’s the first rung on the ladder to help people begin to build wealth.
“Any change, which would significantly raise mortgage rates, particularly for that first time homebuyer, would be problematic.”
Higher credit-score requirements
The Great Recessions lead to a tightening of credit-score requirements. If private Fannie Mae and Freddie Mac have to reduce their risk, they could demand from lenders even higher credit-score stipulations for the mortgages they secure.
This would “further increase the price [of loans] for someone with less than absolutely pristine credit,” says Fratantoni.
Increased interest rates and more stringent credit scores might push more first-time homebuyers toward FHA loans (which already have pretty strict underwriting in terms of income as well as property use and condition, among other things) or private mortgages.
Fewer mortgage products secured by Freddie Mac and Fannie Mae
“There are suggestions that Fannie Mae and Freddie Mac wouldn’t be able to [secure] cash-out refinances or loans to landlords, or loans to second home owners,” says Lewis.
Currently, Freddie Mac and Fannie Mae jointly secure about 70% of mortgages, according to the Urban Institute. As of this February, they also account for about a half of all originations for cash-out refinances.
If Freddie Mac and Fannie Mae reduce their exposure to certain mortgage types, banks and other lenders would have to fill the void, which might lead to the curtailed availability of some loans.
Another possibility is that the enterprises would lower their conforming limits – or the loan amount Freddie Mac and Fannie Mae guarantee, says Lewis.
“Basically that would mean the average loan size would be less, and so they would be more focused on affordable lending,” Lewis says.
Such an emphasis, though, clashes with the likely rise in mortgage rates, which hampers affordability.
Is it worth it?
The intent to release Freddie Mac and Fannie Mae from conservatorship – as well as the timing of the proposal – has spurred criticism.
The enterprises were placed under the scrutiny of the FHFA in the wake of the Great Recession, when they lost billions and failed to meet their mission of providing liquidity and stability to the housing market.
A decade later, Freddie Mac and Fannie Mae’s actions during the coronavirus-triggered economic crisis have proven that conservatorship works well, says Zandi of Moody’s Analytics.
“If the goals are to continue to provide access to affordable mortgage loans to qualified middle-income borrowers, protect taxpayers and ensure that the housing and mortgage markets are less cyclical and also support underserved communities,” Zandi says, “it seems to me that the best way to accomplish that is precisely what we’re doing now, with the [enterprises] in conservatorship.”
FHFA Director Calabria contends that privatizing Freddie Mac and Fannie Mae would provide them the capital bandwidth to “help all Americans in times of stress.”
Zandi disagrees, saying, “If we go down the privatization route, we have to think very carefully and clearly about what roles Fannie Mae and Freddie Mac will have to play if we get into another crisis. If we don’t, in the next crisis, it’s going to be a mess, because Fannie and Freddie as institutions just aren’t going to play the same kind of role [as they do today] unless they’re required to.”