Fed Outlines New Role for Fannie, Freddie

ADVERTISEMENT

Economists, politicians and financial pundits have spent plenty of time mulling the future of Fannie Mae (Stock Quote: FNM) and Freddie Mac (Stock Quote: FRE),  questioning the duo’s future in the mortgage industry. Now the Federal Reserve is starting to fill in that blank, with specific guidelines released last month on what a government-backed mortgage lender might look like.

Here’s the deal: In mid-August, at the Conference on the Future of Housing Finance, the Federal Reserve of New York rolled out new ideas that could drastically reshape the governments’ role in the mortgage lending market.

The New York Fed’s report, “A Private Lender Cooperative Model for Residential Mortgage Finance,” written by analysts Toni Dechario, Patricia Mosser, Joseph Tracy , James Vickery  and Joshua Wright, is described as a set of six design principles for the reorganization of the U.S. housing finance system and would apply them to one model for replacing Fannie Mae and Freddie Mac.

That “one model” is what the report calls a lender cooperative utility. The Fed analysts say, everything being equal, a “co-op” model is the best way to restructure Government Sponsored Enterprises like Fannie and Freddie:

“While each different model for a successor to the GSEs has its own strengths and weaknesses, a private lender cooperative utility may provide the best overall solution based on the design principles listed earlier.”

It’s no secret Fannie and Freddie are both on a fragile financial foundation. Both are in debt for up to $145 billion from government loans. And some estimate it might cost taxpayers up to $1 trillion to ultimately bail them out – money the U.S. Treasury can ill afford to pay in an era of high government debt. Curretly, Fannie and Freddie now account for about 75% of all U.S. mortgage loans.

The Fed report also lays out six “principles for reform” for the U.S. mortgage lending market:

1. If possible we should preserve what worked well with the GSE’s, in particular standardization of mortgage underwriting and the “to-be-announced”(TBA) market.

2. Economies of scale and scope are important design considerations. Scale economies in securitizing mortgages suggest that any mortgage securitizer-insurers should be relatively few in number so long as the design can address how this choice impacts competition in the market.

3. Government housing subsidies should be transparent and accounted for on the government’s balance sheet.

4. In periods of market stress, it may be necessary to have a liquidity provider or perhaps even a “buyer of last resort” for mortgage securities, but this should not be carried out by the new entities unless they are explicitly a part of the federal government.

5. A lesson from the recent financial crisis is that the government ineluctably owns the catastrophe or “tail” risk in housing credit, and if it cannot avoid providing the insurance, then it should make that insurance explicit and fairly priced so that there is no expected long-run cost to the government.

6. The design of any successor to the GSE’s must take a stand on whether the 30-year fixed rate amortizing mortgage with no prepayment penalty is going to remain a key mortgage product.

Consider the New York Federal Reserve one of the first big salvo fired in the debate over Fannie Mae and Freddie Mac’s future.

It certainly won’t be the last.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

Show Comments

Back to Top