2 Ways Abolishing Fannie and Freddie Would Kill the 30-Year Mortgage

The eventual dissolution of Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) began to look a little more likely last week, after President Barack Obama spoke at a Phoenix, Ariz. high school and threw his support behind the push to take those entities out of the housing picture.

In his speech, Obama stated that mortgage financing reform should consist of some basic precepts: The private sector should be the mainstay of the mortgage market; taxpayers should never again be expected to bail out the home loan industry; and the 30-year, fixed-rate mortgage must be preserved. Altogether, these principles should support an affordable home-buying environment, especially for first-time borrowers.

Unfortunately, I don't believe that the last two things are possible if Fannie and Freddie go away -- particularly with the legislation on tap to wind down these entities -- and here are two reasons.

1. 30-year, fixed-rate mortgages would soon become unaffordable
The Housing Finance Reform and Taxpayer Protection Act, put forth by Senators Bob Corker and Mark Warner, would wind down Fannie and Freddie over a five-year period, putting in place a new entity called the Federal Mortgage Insurance Corporation. The FMIC would provide insurance for mortgage-backed securities, collecting money from the MBS-makers in order to take the onus off of taxpayers.

This sounds swell, except for a couple of things. One is that the bill allows financial companies to engage in every aspect of the mortgage investment machine. Institutions would be able to originate mortgages, service them, bundle mortgages into bonds, and collect the private capital for the backstop insurance. As Moody's Chief Economist Mark Zandi notes in a recent research paper, this would put the largest banks in a position to overshadow smaller institutions, stifling competition.

The likely contenders for mortgage-business domination would be familiar names: Wells Fargo (NYSE: WFC  ) , JPMorgan Chase, U.S. Bancorp, and Bank of America. These banks were four of the top five mortgage lenders in 2012, and were also in the top five ranking for having the largest mortgage servicing portfolios, with Citigroup rounding out the latter list.

How affordable would 30-year mortgages likely be with such a small pool of players controlling the whole ball of wax? Not very, I'm sure.

2. Investor interest in long-term, fixed rate mortgages would be non-existent
With Fannie and Freddie backing 90% of all mortgages, it's not surprising that investors have had no qualms about buying MBSes made up of 30-year, fixed-rate loans. Without the current implicit guarantee of payback in times of crisis, however, I seriously doubt investors would want to take a chance on such a long-term investment -- particularly one so interest-rate sensitive.

Indeed, considering the clause in Corker-Warner that enables the government to completely privatize the entire process after eight years, I can foresee all fixed-rate mortgages falling by the wayside, eventually. After experiencing the financial crisis, who in his right mind would want to hang onto an investment vehicle underpinned by 30-year loans -- and no guarantees?

An unnecessary step
If these two institutions are put out to pasture, the entire mortgage landscape will change, and not for the better. Without Fannie and Freddie, I see little chance of a long-lasting housing recovery, as many fewer people will be able to afford a home.

While I understand the need to avoid another bailout of the GSEs, doing so doesn't necessitate the disassembly of Fannie and Freddie. They didn't cause the crisis, and though dissolving them will put the threat of losses on investors rather than taxpayers, this fix smacks of throwing the baby out with the bath water. No one wants a rerun of the financial meltdown, but simply excising Fannie and Freddie from the system seems like overkill, particularly when doing so will likely have such far-reaching ramifications.

The system worked for many years, making home ownership a reality for the masses, thus creating the American Dream. Instead of reacting to the Fannie and Freddie rescue as an opportunity to deposit blame, government should concentrate on making the GSEs work as they were intended -- benefiting both home buyers and investors.

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Read/Post Comments (8) | Recommend This Article (11)

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  • Report this Comment On August 12, 2013, at 11:41 AM, doanngo wrote:

    Great points, I agree 100%. Just enforce rules, regulation, and loop-holes scammed by the banks and the big guys would save lot of money and prevent market from being turbulenced . Leave these 2 companies alone. Politicians must step aside and should not protect banking bad behaviors. Don't waste our tax money to create redundant system to take care of our complex housing system which will takes years to work effectively. Like any system will have tons of loopholes and will cost our tax even so much more. Politicians do not know anything about housing. Just look at the interviews with Corker. When asked about punishment for bad behavior banker, he dogded the question that because they backed by bankers. When he being asked for why replacing Fannie Mae and Mac by the same replica, he just turn his back to the question. That just proved it . Wake up and smell the coffee. Corker-Warner bill Politicians give music to our ears. They just want to say what taxpayers want to hear but they do not have any clue of how to run the system and yet they spoke like eating piece of cake. Like Michael Kao said, stop re-invent and just enforce rules and regulation would save lot of money. Kao had done it before with Ford let people like him to handle this

  • Report this Comment On August 12, 2013, at 11:42 AM, thombiz wrote:

    Fannie and Freddie are and can be very profitable. It you want to protect the taxpayer, require FnF to establish a "rainy day" fund to cover potential losses. Seems so simple! It keeps the 30 year fixed rate mortgage, and it forces any entity wanting in the game to be competitive. It really is that simple!

  • Report this Comment On August 12, 2013, at 1:56 PM, teacheconomics wrote:

    Adding to the above story. Less risk will be taken by the major lenders so there will be less prospective home buyer eligible to purchase a home. Supply and demand takes over. More houses less qualified buyer housing prices collapse more mortgages underwater. Now for the far reaching effects. So we turn our country into a country of renters because we are already seeing our country turning into a country of part time workers. Now we will have all the people and companies that depend on home building suffering or going out of business not to mention school systems which depend on property taxes to run schools. We are a country run by very foolish people sorry to say.

  • Report this Comment On August 12, 2013, at 8:32 PM, infinitemf wrote:

    Excellent Analysis and recommendations.

    Hope lawmakers and decision makers will read this

    article.

  • Report this Comment On August 13, 2013, at 9:21 PM, neamakri wrote:

    Fannie and Freddie perform the ultimate market for mortgages and are incredibly valuable to the entire mortgage industry. For that, we need them.

    They only have one huge problem; political control. When the federal government gave them directives to provide more loans to people with less money, that mostly caused the housing crash.

    Any time the government sticks its nose into private business, it gets screwed up. The bigger the business the bigger the screw up.

    So, a good solution would be to have F&F independent, like the Federal Reserve. Then they could make rational decisions not based on politics.

  • Report this Comment On August 13, 2013, at 10:43 PM, Dangremaus wrote:

    I totally agree. This is a well-written article, Amanda.

    I have an 800 credit score, have never been late on any of my payments, and have a decent income. Yet in going to the major players (Wells Fargo and US Bank), I was always turned down for a mortgage. I would never go to US Bank again for a mortgage and prefer using smaller lenders.

    Dissolving Fannie and Freddie and privatizing the entire mortgage industry at this point would only help the larger banks. Smaller banks won't be able to compete and thousands of jobs will be lost in the long run.

    Our politicians aren't listening because they want to be the "savior" who tried to fix the system. I used to support Obama, but now I'm really losing confidence in everything he says and does.

  • Report this Comment On August 15, 2013, at 9:07 PM, Caludio wrote:

    Hi Amanda, Congratulations on this article!

    very well done! keep writting because most of the people doesnt know the real damage on middle class that will happen if FnF are gone.

    I dont understand why Obama will do this to middle class .... it is unbelievable !

  • Report this Comment On August 21, 2013, at 6:54 PM, promommyfool wrote:

    Caludio,

    It is somewhat believable as the ongoing mortgage clean up costs a fortune in tax money to fix they way the Fed is choosing to do it. Obama is seeing all that money tied up in things he isn't interested in funding. Healthcare is going to require a huge chunk of the federal pie. He is therefore swiping and consolidating as much money from other sources as he can.

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