Fannie, Freddie, And The Future

Crystal BallWall Street Journal (May 8, 2014 by, Nick Timiraos, “5 Takeaways on Fannie, Freddie Earnings” ): “Mortgage giants Fannie Mae and Freddie Mac are sending $10.2 billion to the U.S. Treasury after reporting combined first-quarter profits of $9.3 billion. But Thursday’s earnings reports hinted at a possible cooling off in the profits of both companies, which have benefited from large one-time gains over the past several quarters. They also suggested a modestly softer housing demand.”

Cleaving closely to the Politicians’ Credo For Appearing Busy [“If it ain’t broke – fix it anyway!”] it appears that as Fannie and Freddie return to health, they may go under the knife anyway.  Welcome to the wild, wild, world of D.C. politics, where non sequiturs rule, and wisdom ‘took the last train to the coast.’

Fannie and Freddie, the twin GSEs, had a near-death experience in 2008.  For a more complete discussion, go to my rant post here.  So even though they “…will have sent $213 billion to Treasury by the end of June, around $26 billion more than the amount the Treasury sunk into both companies” the pols think they should be dismantled anyway.  We can only hope that clearer minds will prevail.

The Journal article bears reading, as it summarizes – in hard dollars and good sense – the current financial condition of the GSEs.  Here’s the ‘Reader’s Digest’ version:

  • Although they experienced a banner year in 2013, some of the GSEs’ profit resulted from money previously held as reserves but didn’t need to be used because the losses didn’t materialize.  This was a result of increasing home equity and decreasing foreclosures.
  • The GSEs’ executives confirm that 2014 earnings will not likely repeat 2013.
  • Until May 2013, interest rates were at historic lows; then Fed Chair, Ben Bernanke, unartfully implied that he might soon take his foot off the Quantitative Easing pedal. Jittery investors went crazy – the stock market plunged and interest rates spiked. [For an explanation as to why this occurred, see my post here.] During the low interest rate era, refinancings boomed, as folks stayed in their existing homes and rode out the aftershocks of the Great Recession.  Now, with interest rates a bit higher, and refinancings slowing, banks are seeing fewer mortgage originations.  As the banks’ lending business declines, so do the GSEs’, since the latter purchase most of the conforming loans generated by mortgage brokers and lenders.
  • Chastened after purchasing risky mortgages for investment during the pre-crisis years, rather than securitizing and selling mortgage paper – which was their core business – the GSEs are going back to basics.  However, this means that a major source of revenue, albeit the one that brought about their near death, will no longer exist for Fannie and Freddie.
  • There are some who insist that the GSEs will have to increase their fees if they are to attract private investment in the future – but increased fees may mean increased interest rates.
  • The investor feeding frenzy of Fannie’s foreclosed homes has dropped off, resulting in an increase in its foreclosure inventory for the first time since 2011. More inventory means continued carrying costs.
  • Lenders are delivering loans to Fannie and Freddie of a much higher quality than in prior years. According to the Journal story: “The average credit score backed by Fannie stood at 740 at the end of March, down from 751 a year earlier. Some 1.8% of loans backed by Fannie had credit scores below 620, compared to 1% two years earlier.”
  • In a controversial move, once the GSEs began returning huge profits, the government decided it wanted all the money, thus leaving investors, both large and small, out in the cold.[1]  According to the Journal article, “The terms of the companies’ government backing require Fannie and Freddie to send almost all of their profits to the Treasury, though they don’t owe anything if they run a loss. Investors have sued the companies to challenge those terms, which have depleted them of capital. “ [What this means to me is that the feds are bleeding the GSEs dry, so they will not have any independent means to survive without government assistance.  That’s a pretty good strategy – if you’re a vampire. ~PCQ[2]]

Conclusion. Currently, Fannie and Freddie are caught in a political battle over their future.  The current bill calling for dismantlement [the Johnson-Crapo bill] is stuck in the Senate Banking Committee.  Some Dems are refusing to pass it out of Committee since the bill does not have an “affordable housing mandate” – notwithstanding the fact that it was this “mandate” that pressured the GSEs to jump into the subprime market, to their eventual regret when it crashed in 2007/8.  If the law doesn’t get to the Senate floor, Fannie and Freddie will still be under the government’s thumb – at least for the time being.

My preference is that the feds should get out of the secondary mortgage market entirely, return the GSEs to their previous publicly traded business model.  With investors in a “first loss” position and private mortgage insurance as a backstop, there is no reason, or need, for Big Government or Big Brother.  I say this simply because there is no other alternative entity with the expertise and infrastructure to do what the GSEs presently do.  The Johnson-Crapo bill, for example, calls for a 5-year transition.  Can you imagine a trillion dollar industry moving at the speed of a kabuki dance, from government ownership to private ownership?  It would be a slow motion train wreck.

While this administration would argue that their “wise leadership” was responsible for the GSEs’ profitability today, I would disagree.  Just look at the miserable results of everything the feds touched during the foreclosure crisis: HAMP, HARP 1.0 and 2.0, and HAFA.  Unmitigated disasters, that likely prolonged the recovery.  Then look at the post-foreclosure crisis laws: Dodd-Frank and the CFPB; regulatory nightmares that do nothing but insure that government remains involved in the housing industry at every level.  If the government did such a great job pre-crisis, why was there a crisis at all?  If they did such a good job post-crisis, why does Too Big To Fail still exist?

It was only a matter of time before housing would come back.  It took five long years, no thanks to Washington.  Once housing began to recover, purchase money lending resumed.  There was pent-up demand.  Since Fannie and Freddie were the entities buying the paper, it was only natural they would eventually return to profitability – after all, with the exception of FHA [which today has become the new subprime lender] there was no other viable purchaser for conventional loans.  Fannie and Freddie were the only games in town.  The “private label” secondary market had been dead and buried.

There is not one valid objection to resurrecting Fannie and Freddie.  The only criticism [which is – to put it delicately, pure bovine excrement], is that they caused or contributed to, the financial crisis of 2008.  The GSEs were a victim, just like so many other investors who bought subprime paper – and Fannie and Freddie were “encouraged” to do so under the Dems’ “affordable housing mandate.”

The federal government must restore these corporations to publicly traded ownership, step back, and let private enterprise take it from there.  ~PCQ

[1] Some of these investors were moms and pops who had purchased the GSEs’ shares long before the bailout, due to their generous dividends.  Other purchasers were post bail-out hedge funds, who believed they companies would return to profitability.  For a good summary of this blatant exercise of governmental greed, read the WSJ story here.

[2] Note: A little known fact is that much of the money the GSEs have returned are “profits.”  These funds are not applied to a reduction of the bailout debt.  “Fannie Mae has paid $95 billion of its $117 billion debt, and Freddie Mac has paid $30 billion of its $72 billion debt.”  For a more detailed explanation, see article here.