How Much Will An End To Fannie Mae and Freddie Mac Cost You?

How does a 20-percent mortgage rate hike sound to you? Or maybe more? That might be the effective result if a new GSE “reform” agreement on Capitol Hill ever makes it through the legislative process.

For a very long time the banking industry has complained that Fannie Mae and Freddie Mac have an unfair advantage in the mortgage marketplace, that financial “reform” should mean replacing Fannie and Freddie with firms from the private sector. The two government-sponsored entities, or GSEs, buy and sell loans on the secondary market and are hugely profitable. They have repaid the $187 billion advanced to them by the federal government since 2008 and it’s estimated that the two firms will generate an additional $179 billion in profits during the coming decade.

If Fannie Mae and Freddie Mac were to somehow disappear the immense profits they generate would  go to a new set of players, the big banks and players on Wall Street. And, conveniently, a proposal to privatize Fannie Mae and Freddie Mac has just been agreed to by Sen. Tim Johnson (D-SD), chairman of the Senate Banking Committee, and Mike Crapo (R-ID), the committee’s ranking member.

The Johnson-Crapo plan would “wind down and eliminate Fannie Mae and Freddie Mac.” In  addition, it would “start with S.1217 as the base text and generally maintain its overall architecture.”

Digging a little deeper we discover that the proposed legislation that would create a Federal Mortgage Insurance Corporation (FMIC).This new agency would greatly expand the size of government by taking over Fannie Mae and Freddie Mac. If passed, the bill “transfers, without cost, to the FMIC all functions, activities, infrastructure, property, platforms, or any other object or service of a GSE relating to the maintenance and operation of a GSE’s multifamily guarantee business.”

In other words, the Johnson-Crapo plan would confiscate the assets of Freddie Mac and Fannie Mae without payment to the shareholders, ignoring the Fifth Amendment, the one which says government cannot seize private property without “just compensation.”

But that’s not all.

Higher Mortgage Costs
William Frey, in his book, “Way-Too-Big-Fail,”  writes that without Fannie Mae and Freddie Mac borrowers could see an additional 1 percent added to the annual interest rate of every new mortgage. Given today’s rates of roughly 4.4 percent that’s a 23-percent increase.

Mark Zandi, the chief economist at Moody’s Analytics, offers a more conservative view. He estimates that without Fannie Mae and Freddie Mac the cost of a $200,000 mortgage could increase by $75 to $135 a month. At 4.4 percent interest, that’s an additional cost of 8- to 13-percent for which the borrower gets such benefits as, er, well, um….

Even worse, without Fannie Mae and Freddie Mac mortgage lending could dry up and as a result mortgages could be far more costly, if they were available at all. As Jim Glassman, a visiting fellow at the American Enterprise Institute, points out, 67 percent of all mortgages were originated by private sources in 2006, a percentage which fell to 14 percent in 2012. Are private lenders ready, willing and able to fill America’s mortgage needs without Fannie Mae and Freddie Mac? If so, at what cost? And with what products?

Remember that the reason private-sector mortgages were so popular in 2006 is that the marketplace was filled with toxic option-ARMs, interest-only mortgages and no-doc loan applications — products and practices which lead directly to the mortgage meltdown. Fannie Mae and  Freddie Mac, to their credit, stayed away from such loans, as did the VA and the FHA.

Alec Phillips, an analyst with Goldman Sachs, notes that under Johnson-Crapo private-sector  players would have to maintain a 10-percent capital level, “more than three times the overall mortgage losses experienced by the GSEs since 2007.” Not only are such reserves wildly-unpopular with Wall Street, they raise the issue of federal guarantees: If losses under Johnson-Crapo exceed the reserves set aside does the government stand by and let the financial system collapse or does it bail out the banks? The answer is obvious and no different than recent government bailouts.

The Politics of Johnson-Crapo
The politics of the Johnson-Crapo measure are curious. Wall Street would dearly love to dump Fannie Mae and Freddie Mac and capture the profits they now produce, profits which could be made much bigger with steeper lending fees passed through to consumers in the form of higher mortgage rates. At the same time, Wall Street has no interest in a 10-percent reserve. A reserve of such size would require vast piles of capital to sit idly on the sidelines, money which otherwise could be used to hopefully generate bigger returns.

Real estate brokers are against privatization because they understand that higher mortgage costs would result in reduced home sales and fewer commissions. Community lenders are opposed to Johnson-Crapo because it would make their dwindling ranks even more dependent on the large banks and hedge funds that would take over the secondary market. Republicans are largely against government guarantees while Democrats are generally opposed to GSE privatization.

As to President Obama, it’s hard to know what position he holds. There’s evidence that he will regard the Johnson-Crapo 10-percent reserve as a starting point, that much more  should be expected from private investors if they hope to take over Fannie Mae and Freddie Mac. “Private capital,” said the White House last year, “must be wiped out before the government pays out on catastrophic guarantees provided through government reinsurance of private-market loans.”

In the end the Johnson-Crapo proposal does not explain how the secondary market can be changed without massive federal guarantees, smaller reserves for Wall Street, higher mortgage rates for borrowers or widespread political acceptance. Meanwhile, profits from Fannie Mae and Freddie Mac continue to pour into the U.S. Treasury, money which reduces the federal deficit and the need to raise taxes — the very money which GSE shareholders say should now go back to them, still another complexity with the Fannie Mae/Freddie Mac puzzle and one likely to wind up before the Supreme Court.

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