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Opinion: Fannie Mae and Freddie Mac make the 30-year mortgage possible

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Thirty years is a very long time.

Over three decades, economic conditions will change and change again. And so, in all likelihood, will a person’s circumstances. You might buy a house and then, a decade later, lose your job. Or you might gain a windfall and decide to move to a bigger, better home. Who can know what’s in store over that span of time?

Which is why the 30-year fixed-rate mortgage is such an unusual loan. Banks in other countries don’t offer 30-year fixed mortgages, because they entail too much risk: interest rate risk, prepayment risk and, gravest of all, credit risk — meaning the possibility that the borrower will default. In the U.S., by contrast, the 30-year fixed mortgage is such a staple that nearly 90% of Americans who apply for a home loan want one.

I suspect you already know what makes the 30-year fixed mortgage possible in the U.S.: Those infamous “government sponsored enterprises,” Fannie Mae and Freddie Mac, publicly traded companies created by Congress to help make housing more available to middle-class Americans. Fannie and Freddie accomplish this by doing three things. First, they buy up mortgages from banks, thus freeing up capital so that banks can write yet more mortgages — and help more people gain the American Dream of homeownership.

Second, they bundle mortgages into bonds, and sell them to investors (hence the term “mortgage-backed securities”). Finally, they assume the credit risk for the securitized mortgages they bundle. That is, they guarantee those mortgages against the possibility of a default. Without that guarantee, the 30-year fixed mortgage simply wouldn’t exist. No bank would be willing to assume that risk themselves.

For the past 11 years, Fannie and Freddie have been in “conservatorship” — wards of the U.S. government. They were taken over by the Treasury Department in September 2008, nine days before the bankruptcy of Lehman Brothers Holdings Inc. Having foolishly — and belatedly — jumped into subprime mortgages, Fannie and Freddie were facing big losses. Then-Treasury Secretary Henry Paulson feared that if they collapsed, the entire U.S. housing market would collapse along with them.

Ever since, policy makers in Washington have called for a reduction in the role of the federal government, saying that taxpayers shouldn’t be on the hook if Fannie and Freddie falter again. Indeed, many Republicans believe that Fannie and Freddie should be killed off entirely, and that housing finance should be in private hands. The big banks, irked by the power Fannie and Freddie had for decades over the securitization market, have also agitated for a diminished role for the GSEs.

Sure enough, in 2013, President Barack Obama called for Fannie and Freddie to be wound down, and for the federal role in the mortgage market to be minimized. More recently, the current Treasury Department unveiled a plan that would solve the Fannie-Freddie issue in a different way. It wants to privatize the two companies and eliminate the guarantee, while also imposing a slew of new regulatory controls to prevent another taxpayer bailout like the one that took place in 2008. (The Trump administration plan is still pretty vague.)

To which I can only ask: What’s the point?

What spurs this thought is the news, which the Wall Street Journal broke a few weeks ago, that a number of major institutional investors, including BlackRock Inc. and Fidelity Investments, had met over the summer with administration officials to plead with them not to do away with the guarantee. The investors said that “any move to privatize Fannie and Freddie should include an explicit guarantee of the $5 trillion in mortgage-backed securities they issue, according to people familiar with the matter,” the Journal wrote.

The fact that these big investors felt strongly enough to meet with the White House suggests a cold, hard truth: For all the talk about minimizing the federal role, the housing market simply cannot function without that federal guarantee. And only Fannie and Freddie are in a position to supply it.

Here’s another question: Why do you think Fannie and Freddie remain in government control, even though every Treasury secretary since Timothy Geithner has vowed to end the conservatorship? One reason is that, try as they might, government officials simply haven’t been able to devise a way to maintain the 30-year fixed mortgage without Fannie and Freddie. Another is that ever since the financial crisis, Fannie and Freddie have single-handedly (double-handedly?) kept the housing market alive.

It’s true, as its critics say, that the government had to hand the two companies $187 billion to keep them afloat. (This was in part because they were so thinly capitalized.) But once they recovered, they paid back $250 billion, giving the government a healthy return. (It was not such a good deal for Fannie and Freddie’s shareholders; that $250 billion was profit the government claimed for itself.)

What Fannie and Freddie have mostly lost these past 11 years is the power they once had over the other players in the market. If the banks had wanted to play a bigger role during that time, the GSEs couldn’t have stopped them. But they didn’t — because they needed that guarantee.

Any objective observer, I think, would have to concede that Fannie and Freddie have done a very good job since the 2008 crisis. They’ve done so without worrying about shareholders, or market share, or year-over-year profit gains. What got Fannie and Freddie in trouble was not the government mandate, but their public company impulses. In the years before the crisis hit, they abandoned their historically sound underwriting standards because they were losing market share to the mortgage originators that were writing all those subprime loans that came a cropper when the bubble burst. As government wards, Fannie and Freddie no longer have any incentive to act foolishly.

So I ask again: What’s the point? Why does the government continue to try to wind down Fannie and Freddie, or privatize them, or whatever, when they’re working just fine the way they are? If Fannie and Freddie are going to supply a government guarantee on mortgages, they might as well be part of the government. Letting them loose is only going create temptations — and unduly complicate the housing finance system.

They say that if it ain’t broke, don’t fix it. Conservatorship or not, Fannie Mae and Freddie Mac ain’t broke. - Joe Nocera

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