3 Reasons the United States Should Keep Fannie Mae and Freddie Mac

Despite the renewed efforts to end Fannie and Freddie, there are some very good reasons to keep them around

Jul 10, 2014 at 12:08PM

The decision of whether or not to keep Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) around has been a topic of intense debate lately.

Fannie Mae

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On one hand, we have a group in the Senate that wants to wind down Fannie and Freddie over a period of five years, and replace it with a network of private enterprises, which would have to help absorb some mortgage-related losses before the government helps. The idea is this arrangement will give an added incentive for responsible mortgage lending.

While this sounds good in theory, there are good reasons to keep Fannie and Freddie alive. The agencies are vital to the continued recovery of our housing market, helping struggling homeowners and providing an incentivized marketplace to move foreclosed homes through the market. In addition, keeping the agencies around is the right thing to do for shareholders.

1. Foreclosures
The housing recovery in the U.S. has made excellent progress, but there is still work to be done. According to the FHFA's latest foreclosure prevention report, about 4% (or 1.1 million) of Fannie and Freddie's mortgages are currently in some stage of delinquency.

About half of these are seriously (90 or more days) delinquent and a good portion of these will likely end up in foreclosure. And, as long as there is a steady stream of foreclosures hitting the market, Fannie and Freddie play a crucial role.

Both agencies have their own marketplaces designed to sell foreclosures quickly by incentivizing their purchase. Fannie Mae's HomePath and Freddie Mac's HomeSteps programs both offer special financing to buyers, allowing them to buy a foreclosed home for as little as 5% down with no mortgage insurance and no appraisal requirement.

There are also loans for homes needing renovations, as well as a variety of options for investors. There are currently tens of thousands of homes listed by the programs, and until the foreclosure epidemic is truly over, these two programs play an essential role in moving tough-to-sell homes through the marketplace quickly.

2. Homeowner help
Fannie and Freddie also play a very important role in helping struggling homeowners stay in their homes. If a homeowner owes more than their home is worth, or simply has a very expensive adjustable-rate mortgage, the agencies offer programs to help.

During the first quarter alone, nearly 55,000 home loans were modified by refinancing, changing the interest rate, extending the loan's term, or simply by reducing the principal balance of the loan.

Before dismantling Fannie and Freddie, there needs to be a similar assistance program in place to deal with the homeowners still struggling as a result of the housing crash.

3. Investors deserve a chance to profit
Several government officials have made it abundantly clear that it is not their priority to make sure Fannie and Freddie's shareholders are taken care of.

While it's completely understandable to prioritize a stable and healthy housing market over the desires of investors to profit, the government should still do the right thing here. Fannie and Freddie have repaid every dime they received as a bailout, and the Treasury has actually seen more than $25 billion in profit from the agencies.

A group of shareholders led by Fairholme Capital's Bruce Berkowitz has said the agencies could be restored as private companies, a statement which has been contested by Treasury officials. In all, the Treasury is facing about 20 different shareholder lawsuits challenging the current arrangement, under which 100% of Fannie and Freddie's profits go to the government. Even the preferred shareholders aren't getting anything.

While this is a matter for the courts, the shareholders make some good points. For instance, if shareholders were to be left with nothing, why were the common and preferred shares allowed to keep trading? And, Fannie and Freddie were placed in "conservatorship", and what that is supposed to mean is certainly not what is happening now.

What is most likely to happen
I believe Fannie and Freddie will be kept alive for the foreseeable future, simply because of their vital role in the very fragile housing recovery. Congress and the U.S. Treasury are both scared to death of undoing the progress that has been made so far, and will err on the side of caution when making policy decisions regarding Fannie and Freddie.

As far as the shareholders are concerned, it is anyone's guess. It's really hard to make the case investors who own the common and junior preferred shares don't deserve a cut of the profits. However, this doesn't mean they'll prevail in court.

If Fannie and Freddie are kept alive, there is a good chance the courts will allow investors to share in the profits. It could also go the other way just as easily, leaving shareholders with nothing.

Whatever happens, Fannie and Freddie are simply too vital to the U.S. housing market right now to get rid of. Ideally, there will come a time in the future when the agencies are no longer needed to create and maintain a healthy and accessible mortgage market, but the time has not come just yet.

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Matthew Frankel 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.

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