Fannie and Freddie Are Dead. What's Next?

"This committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance; that's the approach, rather than the piecemeal one." -- Rep. Barney Frank, Jan. 22, 2010.

What if Frank isn't just talking out of his rear, and Fannie Mae (NYSE: FNM  ) and Freddie Mac are really on a path to being put out of their misery? What would happen?

Your guess is as good as mine. Frank offered exactly zero details. Logically, major overhaul of Fannie and Freddie would either be:

  • A complete eradication of their roles, ending government-backed mortgage securities and loan insurance.
  • A continuation of their current roles, but only after being brought 100% onto the government's books.

Here's a rundown of each possibility.

1. Complete eradication
To the dismay of Randians everywhere, this possibility really seems like a dream. The odds of completely ending Fannie and Freddie's roles in the housing market are about the same as completely ending Social Security.

Why? Because despite the glaring flaws, the fact is there's essentially no functioning mortgage market outside of government-backed issuance. This table gives an idea just how reliant the market is on the two:   


Share of First Mortgages Outstanding

Fannie Mae


Freddie Mac


Banks and Thrifts




Private Label Securities


Source: Freddie Mac.

And that's just the market share of outstanding mortgages. The market share of current mortgage issuance is even more lopsided. Fannie and Freddie combined currently make up about 70% of new mortgage issuance, with the FHA taking up close to 20%, for a total of around 90% reliance on these three government-backed vehicles.

Why such reliance? The best explanation is that large banks -- like Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , JPMorgan Chase (NYSE: JPM  ) , and Wells Fargo (NYSE: WFC  ) -- don't have the appetite to lend directly to homeowners after being sufficiently wrecked by housing over the past three years. Also, with the yield curve the way it is, it makes sense for banks with a long-term outlook (I'd like to believe they exist) to invest in short-term Treasury securities instead of longer-term assets like mortgages. Wells Fargo recently admitted it's doing just that.

Second, the market for private securities (like CDOs) packaged by banks like Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) is virtually extinct compared with prior years, because investors now know how dangerous they can be.

At any rate, know this: If private banks were the only issuers of mortgage funding, the cost (interest rate) would blow up in a big way. To compensate, housing prices would get nuked. For example, a 30-year fixed mortgage at 5% with a $1,500 monthly payment will finance around $275,000 worth of house. The same $1,500 mortgage at 9% will only finance about $185,000.

Few politicians want to explain to their constituents why annihilating home values is worth it -- that's why there's very little chance that Fannie and Freddie's roles will actually be eradicated.

2. Continued roles, fully owned by Uncle Sam
The most likely "new system of housing finance" Frank wants is a continuation of the government-backed mortgage market, but only after Fannie and Freddie's assets and liabilities are brought entirely onto the government's books.

As it stands, Fannie and Freddie are essentially wholly owned wards of the state. But since both still technically hold private company status, the assets and liabilities don't fall directly on public books. Seriously. Even though their balance sheets are funded and guaranteed by the public, the obligations don't show up on budget deficit and national debt statistics beyond the incremental cash infusions given to keep the two afloat. (Everyone, go find an accountant and flip them off.)

Officially bringing these liabilities onto pubic books could increase the national debt (currently $12.3 trillion) by something like $7 trillion -- roughly the amount of mortgages the two hold or guarantee, plus unsecured corporate debt.

This isn't as bad as it sounds because the majority of these mortgages will stay current, or are at least backed by real estate. Nonetheless, metrics that investors and credit rating agencies use to judge the soundness of public finances (like debt-to-GDP and debt held by the public) would explode, possibly sparking a credit downgrade and scaring away the benevolence of foreign investors that trillion-dollar deficits so desperately need.

What do you think about it all? Share your thoughts in the comment section below.

For a great explanation on what Fannie and Freddie really do, check out this classic Bill Mann article.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (22) | Recommend This Article (43)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2010, at 11:36 AM, neutrinoman wrote:

    Yes. I'd like option #1, but option #2 is acceptable -- at least it's more honest than our current hypocrisy.

  • Report this Comment On January 25, 2010, at 12:48 PM, BMFPitt wrote:

    Fannie & Freddie are as dead as Jason Voorhees. Except way more dangerous.

  • Report this Comment On January 25, 2010, at 12:49 PM, langco1 wrote:

    fannie and freddie are soon to be the only mortgage lenders as banks hold off with growing forclosure.these 2 are government backed and a sure investment to gain...

  • Report this Comment On January 25, 2010, at 1:40 PM, aggie9711 wrote:

    This is exactly why these programs need to be killed before they are hatched by Congress. They get so intertwined into the economy, you can't cut them out without eviscerating the productive portions of the economy. That's why SS and Medicare will go bankrupt, everyone knows it, and no one will do a damn thing about it.

    #2 is the only possibility and I am 100% sure that is what will happen. Why? Because Barney "Roll the Dice Some More, Don't see a Problem, Fannie Mae Cheerleader" Frank is talking about it.

  • Report this Comment On January 25, 2010, at 2:07 PM, Lasertop wrote:

    Niether will happen if the Democrats have half a brain, lets face it adding 5 to 7 trillion to the national debt will sink the already fragile economy. And with Elections coming up in November it would be sucide.

    The better solution would be to return both Freddie and Fannie to the private sector, forgiving a portion of the money the tax payers gave them with some basic common sense rules in place (like say not giving money to people who clearly can't afford it)

    Its Ironic that Barney Frank is the same guy in 2000 that pushed forward the "Affordable Housing Act" so every American could afford a home. Now that it has all come tumbling down he has a new fix for us.

  • Report this Comment On January 25, 2010, at 4:36 PM, qqac wrote:

    I agree with Lasertop. Fannie and Freddie need to exist, and they should be private companies with full access to capital markets--far better to rely on private capital than to be on the public books. The main reason they got into trouble is the federal government mandate that they promote homeownership, even by those who could not afford it. If Barney Frank would only shut up, then and now, things would be fine. Perhaps with Scott Brown's win in MA, someone will be successful in taking Frank's seat.

  • Report this Comment On January 25, 2010, at 7:01 PM, oneinstance wrote:

    Greetings everyone. I still have some FNM stock (I know, I'm not very smart), so could anyone enlighten me what will happen to it under scenarios 1. and 2.?

    Much appreciated, thanks.

  • Report this Comment On January 25, 2010, at 7:02 PM, oneinstance wrote:

    Greetings everyone. I still have some FNM stock (I know, I'm not very smart), so could anyone enlighten me what will happen to it under scenarios 1. and 2.?

    Much appreciated, thanks.

  • Report this Comment On January 25, 2010, at 8:35 PM, CAPTAINWACK wrote:

    "liabilities onto pubic books" Ah, what the heck does that mean?

  • Report this Comment On January 25, 2010, at 8:37 PM, CAPTAINWACK wrote:

    "liabilities onto pubic books" Ah, what the heck does that mean?

  • Report this Comment On January 25, 2010, at 10:39 PM, rd80 wrote:

    "...the fact is there's essentially no functioning mortgage market outside of government-backed issuance."

    An alternate way to put this would be there's essentially no functioning mortgage market because of government-backed issuance. FNM and FRE are buying mortgages at a loss in order to drive rates down - no commercial mortgage lender can compete with institutions that at purposely losing money.

  • Report this Comment On January 26, 2010, at 12:52 AM, cmfhousel wrote:


    Always appreciate your input. That is a great, and accurate, way of looking at it.


  • Report this Comment On January 26, 2010, at 1:29 AM, tnsw2k wrote:

    You have to read the 2nd part of Barneys statement "coming up with a whole new system of housing finance" - what this means is keep FM&FrM off the govt books as a zombie debt and start a brand new Zombie lender/underwriter with no current debts. Then, in 10-15 years, rescue that one with more taxpayer dollars

    I say NO - retire FM&FrM and then no more government interference in housing finance. Government interference distorts the true cost of housing, distorts interest rates, and costs taxpayers $7Trillion to date. No More.

  • Report this Comment On January 26, 2010, at 6:51 AM, Centerline75 wrote:

    This one's easy...... It's all Bush's fault, just like that Senate seat Ted Kennedy owned.

  • Report this Comment On January 26, 2010, at 10:35 AM, ThatRichKid wrote:

    yup they're dead.

  • Report this Comment On January 26, 2010, at 11:08 AM, BMFPitt wrote:

    For those who say that Fannie & Freddie should exist (other than qqac who doesn't seem to know he's saying they shouldn't exist), I ask what the benefit they bring to ANYONE other than banks, mortgage brokers, and real estate agents?

    It's not just the fact that they are an unforgivable monstrosity of a waste of taxpayer money, it's that they significantly harm the American people by inflating house prices. The problem with housing wasn't that the bubble popped, the problem was the bubble itself (which has gone on longer than anyone admits, and is still vastly overinflated today.)

    It will never happen, but the only way to fix housing it to get the government out of the market completely. Remove EVERYTHING that is propping it up, right on down to the mortgage interest deduction.

  • Report this Comment On January 27, 2010, at 9:14 PM, ram7017 wrote:

    Considering the Fed's announcement that they will no longer purchase MBS's after March 31st, how will this affect the odds of either of these scenario's happening? Obviously the Fed will still own the $1.25 trillion dollars worth of them it purchased so it's not a complete withdrawal from the situation. To me, it's more of a shift to scenario #2 from above, and if/when the real estate market continues its downturn, it will give them a reason, or even a "moral obligation", to take even more ownership of the situation.

  • Report this Comment On January 29, 2010, at 2:19 PM, nsdrguy wrote:

    Long term problems need long term solutions. A significant part of the problem is that these GSEs have charged too little for their services (loans and loan guarantees), required too little documentation, and let mortgage companies sell them cxxp mortgages.

    A quick return to private housing financing would blow up the country. Increasing home financing rates quickly would tank housing for many years. So there needs to be a GRADUAL return to reality. Reality means higher rates, more documentation, and better quality mortgages ( no more 95% loans on no doc loans).

    So far, the GSE's continue to provide low down payment, low rate, moderate documentation loans, with inadequate fees for such loans and insurance. Better than before but not good enough.


  • Report this Comment On January 29, 2010, at 5:48 PM, drborst wrote:

    I always had a feeling that when they did the stimulus and kept rejecting ideas because they weren't 'Shovel ready' they were making a mistake. Everyone could see last year that this was going to be a long and deep recession, one that needs a long and deep comitment to get us out.

    The Fannie and Freddie problem is going to take 10 years to fix, anything faster will crush us. I don't trust Mr Frank to fix anything that takes more than a two year election cycle.

  • Report this Comment On January 29, 2010, at 6:02 PM, robertinvestor wrote:

    Since the government got more involved with them.The are writing more bad loans 3% down ,125% equity etc.

    Government would do more

    Whats needed

    low rate for

    none investor with 10% down

    investor 20% down

    Problem solved

    Got people who then have skin in the game

    Wrighting bad loans only means more problems in the future.Nothing solved besides adding to our debt

  • Report this Comment On January 29, 2010, at 11:53 PM, VintonCounty wrote:

    National government lending to citizens or cosigning their mortgages is unconstitutional. Your attitude about the roles of Fannie and Freddie depends on your respect for the Constitution.

  • Report this Comment On January 30, 2010, at 8:23 AM, lbddotcom wrote:

    There is a finite number of loans any company can make at $275,000 or $185,000 and get it back at $1,500 a month. Same with Fannie and Freddie buying them. They turn around and sell them too, and maybe they get sold again, eventually to a buyer who is happy to have that kind of return. A secondary market is necessary to keep loan originations and a piece of the economy, which is money moving around, going. Doesn't necessarily have to be Fannie or Freddie or the government providing it, but without one eventually lending would stop.

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