Inside Fannie Mae and Freddie Mac’s Billion-Dollar Machine

Fannie Mae and Freddie Mac's core business will enjoy some additional pricing power in 2015, analysts suspect.

Jun 10, 2014 at 12:10PM

Often relegated to the pile of "financial blackboxes" among investors, Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) are incredibly profitable. But new changes coming down the pipeline could lead to even fatter bottom lines.

Fannie and Freddie's bread and butter
Fannie Mae and Freddie Mac's core business is simple; they insure the bulk of America's mortgages in exchange for a fee. These fees, known as guaranty fees, or G-fees, have been the subject of recent scrutiny by investors and the government alike.

Since the 2008 financial crisis, guaranty fees have become even more lucrative for Fannie Mae and Freddie Mac.

G Fee

But the government is interested in raising guaranty fees even higher. The FHFA is currently accepting comments on a plan that would increase guarantee fees to encourage private insurers to take a greater share of the market.

Why guaranty fees matter
Guaranty fees are important for homebuyers and Fannie and Freddie Mac alike. Homebuyers silently pay the fee, first upfront, and then every single year thereafter as a percentage of their unpaid principal balance. Increasing fees simply adds to the spread that mortgage lenders need to underwrite a profitable, conforming loan.

For Fannie and Freddie, fee levels ultimately determine profitability. In a filing for comments, the FHFA detailed three alternative scenarios in which the GSEs held varying levels of capital, and sought a 9% annual return on capital.

The scenarios suggest the GSEs need to generate "G-fees" of anywhere from 0.67% to 1.36% on each new mortgage they back. Fees are currently lower than even the low range of the model at 0.55% in the fourth quarter of 2013.

A matter of policy
Given that Fannie Mae and Freddie Mac are currently in conservatorship, whatever fee level the FHFA deems appropriate will determine the profitability of the GSEs for the U.S. Treasury. This is, in some sense, a question of how much the U.S. Government can reasonably extract from the American housing market.

After all, increasing G-fees will naturally cut down on loan demand, since higher fees result in a higher interest rate for the borrower. Recent increases in mortgage rates have stymied some purchase and refinance demand, so it's a delicate balancing act between killing housing demand and operating profitable mortgage insurance companies.

In the end, analysts are calling for a 10 basis point increase in fees. This would be consistent with a 10 basis point increase that was mandated to help pay for the Temporary Payroll Tax Cut Continutation Act in 2011, which, among other things, held down the individual-level payroll taxes throughout 2011 and 2012.

Any increase in "G-fees" wouldn't happen until 2015 at the earliest, given the commentary period ends in August and the FHFA will review the idea for six months before choosing to act. Fee increases do tell us one thing: The government wants to run the GSEs as profitably as possible, and by raising fees, it's encouraging greater private competition.

Winding down Fannie Mae and Freddie Mac may be as easy as increasing prices on government-sponsored mortgage insurance.

Warren Buffett isn't betting on FNMA. He's buying this stock.
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!


Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information