For over 50 years Fannie Mae (NASDAQOTCBB: FNMA), Freddie Mac (NASDAQOTCBB: FMCC), and Ginnie Mae (a.k.a Government Sponsored Entities or "GSEs") have facilitated funding most conforming-balance fixed-rate mortgages in the United States. As a result GSEs have been the foundation of the U.S. housing finance. Although FNMA and FMCC were private entities, investors had viewed them so critical to the mortgage and financial system that the U.S. Government would bail them out if they got in trouble. This is described as "implied guarantee". For a many years Congress and the Administration have feared such a bail out and had been trying to reduce dependence on the GSEs but were not able to develop the right political consensus. The fear finally materialized and the credit crisis forced the GSEs to file bankruptcy and government had to bail them out. Post credit crisis GSEs become the lander of the last resort and grow even bigger. This has led to the general consensus that the status quo in which Fannie Mae and Freddie Mac remain in conservatorship is no longer a viable option for the U.S. housing finance system and not an acceptable risk to be borne by the taxpayers. As a result the administration and Congress want to wind down the functions of Fannie Mae and Freddie Mac and turn the functions of the secondary mortgage market over to the private sector. The federal government will play a much more limited role in the housing market through the Federal Housing Administration (FHA).
The long-awaited reform proposal for the U.S. housing finance system and GSEs was finally released by the Committee on Banking, Housing and Urban Affairs on March 11, 2014. The comprehensive plan provides for a five-year winding down of the current GSE model. The eventual establishment of a Federal Mortgage Insurance Corporation (FMIC) and mandating 10 percent private capital up front are essential to the plan. The five-year transition period to the new system requires the creation of specific benchmarks and timeline for FMIC and private-sector participation.
Most experts agree that a critical contributor to U.S. economic prosperity and long-term growth has been the existence of a healthy, stable and reliable housing finance system that integrates both public policy and private economic forces. The contentious debate has been the separation of the roles of GSEs and the private sector.
GSE-guaranteed conforming mortgages have been the primary driver in the standardization of conforming-balance, fixed-rate mortgages (fully amortizing over 30 or 15 years) that has led to a highly liquid $5 trillion securitized Agency residential mortgage-backed securities (RMBS) market. The corresponding to-be-announced (TBA) Agency forward trading has also been critical to the growth of the market. The development of the liquid TBA market allows easy hedging of the origination pipeline and hence incentivizes small and large mortgage originators to expand their lending operations with modest amounts of capital. The GSEs and Ginnie Mae have been charged with enhancing the flow and reducing the cost of credit for housing in the United States. They are the most critical mechanism through which mortgages are financed.
The soundness of U.S. Agency RMBS threads through the stability of the entire financial system as it constitutes a significant core investment of all banks, credit unions, REITs and insurance companies domestically and to a lesser extent globally. A major risk is any significant flaw in the implementation of the reform proposal will have negative impact in the soundness and liquidity of these financial institutions and could impact the stability of the entire financial system globally.
Developing a highly liquid securitization platform under the new model will be critical to its ultimate success. The new platform is mandated to issue a standardized security guaranteed by the FMIC. The FMIC securitization platform will be owned by members. The new system will also strive to maintain a highly liquid TBA market for hedging new and secondary issues. The liquidity of the legacy Agency RMBS should also be maintained.
At a first glance, the bipartisan proposal by Congressmen Tim Johnson (D-SD) and Mike Crapo (R-ID) seems to address all the right issues and be well intended. However, time and again the market has come to doubt congressional initiatives to reduce reliance on GSEs. Perhaps this time congress' crying wolves may be real, but many believe dismantling GSEs may still be a pipe dream given their 50-year-long success to be the envy of the world in establishing a robust housing finance system. Time will tell.
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