Eliminate Fannie Mae and Freddie Mac News2america

Fannie Mae and Freddie Mac’s recent request for a bailout from the U.S. Treasury (read American taxpayers) has brought back into the public’s eye the unresolved legal status of these two government sponsored enterprises. In this debate, the assumption is that the GSEs, or some replacement entities benefiting from a government guarantee, are necessary for an effective housing finance market.

The GSEs, however, do very little that cannot be done – and is not already done – by the private sector. In addition, these institutions pose a significant financial risk to U.S. taxpayers. Weighing this cost against the minimal benefits makes the case that the GSEs should be eliminated.

Without the GSEs, the mortgage market would not look radically different than it does today. Proponents argue that the GSEs lower mortgage rates, ensure the availability of the standard 30-year fixed rate mortgage, support home ownership and lend to people with lower incomes or weaker credit profiles, all of which the private sector presumably would not do. Not true on all fronts.

First, the GSEs do not offer lower mortgage rates for consumers despite a government guarantee that allows them to raise capital at a lower cost than the private sector. In the past, the GSEs were able to charge lower mortgage rates by taking risks for which they were not compensated. The result was a massive build-up of housing risk in the run-up to the financial crisis of 2007-08.

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Since 2009, the GSEs have been required to recognize risk in their pricing of mortgages, which has driven up their mortgage rates relative to the private sector. As a consequence, since 2014, new research undertaken with my colleague Steve Oliner shows that mortgage rates for private portfolio whole loans have been about one-quarter percentage point below GSE rates – after controlling for risk characteristics.

And contrary to Treasury Secretary Steven Mnuchin’s recent statement, the private market could ensure the availability of the 30-year fixed-rate mortgages on its own. Data from CoreLogic show that 76 percent of private portfolio mortgages originated in 2017 were 30-year mortgages, not much below the GSE’s 85 percent share.

Furthermore, the GSEs’ impact in promoting homeownership is vastly overestimated. The latest 2016 housing data collected under the Home Mortgage Disclosure Act show that six out of 10 GSE mortgages had nothing to do with purchasing a primary residence – and only about one-third of these primary purchase loans went to borrowers with incomes below the area median. GSE borrowers with loan amounts over $200,000 were generally affluent, with a median income 60 percent above the median income of all households in their metro area. So why should taxpayers be on the hook for these borrowers?

The data also show that despite the GSEs’ dominant role, private portfolio investors – mostly large banks – are already very active in the home purchase market. For loans below the 2016 conforming loan limit, which is the maximum loan amount eligible for purchase by the GSEs, private investor loans totaled $228 billion and accounted for a fifth of the combined total of GSE and private loans. Private portfolio loans below $200,000 accounted for a quarter of total loans. While GSE borrowers below $200,000 had a median income a shade under the area median, private sector borrowers in the same range had even lower incomes. Based on these data, it is simply not true that lower income borrowers are shunned by the private sector.

Although it is true that the GSEs’ credit box is somewhat wider than that of private portfolio lenders, over two-thirds of 2016 GSE primary purchase loans would fit inside the portfolio lenders’ credit box without any change in down payment or the price of the home purchased. Many GSE borrowers, given their affluence, could increase their down payment – or opt for a less expensive home. Either adjustment, or both together, would increase the percentage of loans that meet the credit standards of private lenders.

So why do we not see more private portfolio loans today? The simple answer is that regulators have tilted the playing field in favor of the GSEs. Rapidly rising house prices are rendering GSE loans more attractive relative to portfolio loans, because regulators have allowed GSE loans to carry a debt-to-income ratio of 50 percent, while making it costly for the private sector to exceed a ratio of 43 percent. GSE borrowers can thus take on more debt to offset higher prices. With inventories lower than ever, this extra debt ends up driving prices even higher, creating a vicious cycle of more debt, higher prices, greater risk and, ironically, more demand for the GSEs. What keeps the GSEs in business are the same failed housing policies that brought us the last financial crisis.

The GSEs are not needed in the housing market – and they have become detrimental to the market’s long-term health. They could be eliminated simply through a gradual reduction in the conforming loan limits. This would create space for the re-emergence of an active private mortgage-backed securities market that ensures a safer and more stable housing finance system with access for all while letting taxpayers off the hook.

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