There is a reasonable chance that the incoming Congress will finally attempt to tackle the contentious issue of GSE reform. However, radical changes to the GSEs (with some discussion of eliminating them entirely) have the potential to seriously disrupt the mortgage and housing markets. Despite their depleted financial condition, they remain entrenched in housing finance, as more than two-thirds of MBS are being issued through Fannie Mae and Freddie Mac.

Despite calls by politicians and columnists suggesting that the GSEs can be replaced by the "private markets," there is currently no private issuance mechanism that can immediately assume their role. Private-label issuance since the end of 2007 has been miniscule, resulting in opaque pricing and subordination levels for new transactions. A back-of-the-envelope analysis implies that private-label execution would translate to primary conforming mortgage rates hundreds of basis points higher than current posted levels. The collective balance sheet of the U.S. banking system is also not large enough to finance the housing market on its own.

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