A $4 Trillion Risk Tied to Freeing Fannie & Freddie Could Hurt U.S. Homebuyers

The Trump Administration’s urgency to free Fannie Mae and Freddie Mac from federal control has some on Wall Street worried that it might happen without the U.S. government providing an explicit backstop of the companies’ $4.7 trillion of mortgage securities.

Credit rating companies, financial firms and even real estate agents claim that such a move would be a disaster. They’re warning that ending Fannie and Freddie’s conservatorships absent a clear guarantee of their securities might prompt big asset managers to curtail their bond buying. That in turn could dry up some of the financing that keeps the mortgage market humming, making it harder and more expensive for consumers to get home loans, they say.

“Conservatorship is safe. An explicit guarantee is safe. Keeping Fannie and Freddie as they are and privatizing them is a dangerous experiment,” said Michael Bright, president of the Structured Finance Industry Group and the former acting president of Ginnie Mae. He co-authored a 2016 plan that proposed turning Fannie and Freddie into lender-owned insurers that could issue mortgage securities with federal backstops.

An explicit guarantee can only be provided by Congress, which has failed for more than a decade to agree on a fix for Fannie and Freddie. Concern that the administration might try to release the companies with no federal backstop has largely been triggered by their regulator, Federal Housing Finance Agency Director Mark Calabria. An appointee of President Donald Trump, he suggested in media interviews last month that he thought Fannie and Freddie could survive without one by building up capital buffers and reducing market risk.

‘Limited Guarantee’

Calabria said Thursday at a conference in Washington that if lawmakers create a guarantee — something he hasn’t formally asked them to do — it should be “limited.”

Treasury Secretary Steven Mnuchin, who Calabria will collaborate with on many reforms, has said that he would prefer there be an explicit backstop, though he hasn’t ruled out bypassing Congress to free Fannie and Freddie. Mnuchin has also been clear that he wants an overhaul of U.S. housing-finance policy to accompany any push to end the conservatorships, indicating he might be hesitant to make any bold moves. Treasury is working on a plan for what to do with Fannie and Freddie that is expected to be released in the coming weeks.

Spokesmen for the FHFA and Treasury didn’t reply to requests for comment.

The reason why a federal guarantee of mortgage bonds is important is because of the essential role that Fannie and Freddie play in the housing market by buying loans from lenders and then packaging the debt into securities. If asset managers were to curb their bond buying — due to worries that they could lose their interest and principal — mortgage rates would likely rise and credit might become less available to home buyers.

Curtailed Buying?

Without an unequivocal guarantee “there’s a whole host of buyers that currently buy these mortgage-backed securities that may not be able to, or may not want to,” said Brian Quigley, a fixed-income portfolio manager at Vanguard Group, which manages $5.6 trillion.

The warning shows the potential dangers for Trump in trying to tackle such a complicated issue that touches heavily on voters’ finances. The president’s chances of winning a second term will likely hinge on the health of the economy next year, and tampering with Fannie and Freddie poses risks with questionable political upside.

While investors say they are worried about there possibly being no federal guarantee, any concerns haven’t yet shown up in bond prices. And mortgage rates remain low.

Before the 2008 financial crisis, which prompted the U.S.’s takeover of Fannie and Freddie, investors believed that the government would bail the companies out and backstop their mortgage securities, even though no law or regulation said that was the case. Critics say Fannie and Freddie exploited that “implicit guarantee” by holding too little capital and dangerously ramping up risk, moves that ultimately led to the companies’ needing a rescue.

Treasury Funds

In conservatorship, Fannie and Freddie have been assumed to have the full backing of the U.S. government. That perception is bolstered by the fact that if the companies suffer losses, they can draw on $258 billion from the Treasury.

Those billions of dollars could help mitigate the need for an explicit guarantee of mortgage securities, if the funds remained available to a privatized Fannie and Freddie. Calabria and Mnuchin have also said that they want the companies to raise enough capital to endure a financial meltdown, and such a total could exceed $200 billion.

But some mortgage-finance experts argue that all that money still wouldn’t be adequate to assuage bond investors. Chris Whalen, a former debt rater at Kroll Bond Rating Agency, said regulators might be using the threat of releasing Fannie and Freddie without a guarantee to force Congress to agree to a legislative fix to end the conservatorships, something lawmakers have repeatedly fallen short of since the 2008 crisis.

“Part of me thinks that they’re just bluffing and they want Congress to act,” said Whalen, chairman of Whalen Global Advisors. “When you start messing with the basic infrastructure in the mortgage finance world, you’re looking at some serious risk. When volumes fall in the mortgage industry, the Realtors, home-builders and bankers are going to come to Washington and crucify these lawmakers.”

Realtors Worried

There’s evidence that’s already happening. The National Association of Realtors sent Calabria a June 3 letter saying “a curtailed or eliminated guarantee could raise costs and threaten access to credit.”

Another potential impact of freeing Fannie and Freddie without an explicit guarantee is uncertainty over whether they could maintain their AAA credit ratings — the highest possible.

“Absent some sovereign support that we could point to, I think we would have to question whether the AAA rating that we have on the enterprises would still hold,” Fitch Ratings’ Chris Wolfe said in an interview.

Scott Simon, the former head of mortgage-backed securities at Pacific Investment Management Co., said many bond investors, including foreign central banks, bought Fannie and Freddie securities because the assets were perceived to be free of credit risk. Releasing the companies without a clear government backstop would test that assumption, as well as much of the infrastructure that underpins the U.S. mortgage market, he said.

“The banks aren’t set up for this. The money managers — Pimco, BlackRock — they aren’t set up for this,” Simon said in an interview. “This system has been in place since the 1980s.”

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