Fannie Mae and Freddie Mac last week found some congressional support for their controversial foray into subprime mortgages when Senator John Kerry, D-Mass., urged them to expand their role in the subprime market.
Kerry's comments, as well as comments by other key Democratic lawmakers, seem to indicate that the Democrats favor greater participation by the GSEs in the subprime market, provided the objective creates a more efficient market for those consumers without unduly incurring risks to Fannie and Freddie.
"The subprime market lacks the standardization and transparent pricing policies that Fannie Mae and Freddie Mac have brought to the rest of the conventional-conforming market," Kerry said in a letter this month. Due to the lack of these efficiencies, subprime financing "costs consumers over 1% more for financing than is justified even considering their higher risk profile," he continued.
Another potential argument for the GSEs' presence in the subprime market noted in Kerry's letter is an abuse in lending that has recently come to light: When borrowers improved their payment records, some subprime players kept the improved history secret from the credit bureaus to prevent their borrowers from using this information to refinance into a lower-rated mortgage.
While few would argue with Kerry's goal of creating a more efficient mortgage market for subprime borrowers, a number of industry participants don't think the GSEs should be the ones to do that.
A number of mortgage insurers and private-sector lenders have joined forces to combat the GSEs' move into subprime lending, fearing that the agencies will eventually cut into their business. They argue that areas like mortgage insurance, which Freddie Mac has provided on subprime mortgage deals, are not part of the agencies' charter mission.
This year, as part of an ongoing effort, Freddie Mac has guaranteed all or part of two Option One subprime securitizations totaling $1.315 billion. And last October, Freddie introduced a program to buy A-minus loans on a flow basis through its automated-underwriting system, Loan Prospector.
For its part, Fannie Mae says it isn't targeting borrowers with very poor credit; rather, its aim is to reach people whose credit is good but falls slightly short of prime. In short, Fannie Mae calls its approach to the subprime market "making As" out of loans that might otherwise be considered subprime. "As we continue to develop our strategy, we will report back to him [Kerry] on our progress," said a Fannie Mae spokesman.
"We believe there are ways to create more efficiencies for consumers now served by the subprime market to help them move to move to an A' rating and thereby help them move into the conventional conforming market," he added.
As it stands now, Wall Street seems to have mixed emotions about the GSEs' presence in subprime mortgages. Sources noted that during the liquidity crunch last fall, Fannie Mae and Freddie Mac were virtually the only bid for home-equity loan-backed securities. At the same time, however, there is a fear that they could emerge as a real threat to subprime lenders, who unlike a GSE tend to rely more heavily on underwriting firms to sell deals.