The U.S. Congress might finally kill Fannie Mae and Freddie Mac, the two mortgage giants that still raise the capital for the vast majority of home loans.
“We have a real opportunity to make reform happen,” said Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development, at an event hosted by the Bipartisan Policy Center and the New York University Robert F. Wagner Graduate School of Public Service on April 22 in New York City.
Donovan threw his support behind a bipartisan Senate proposal that would create a new home mortgage finance system. He called the proposal “an important and positive step” that would put limits on the government’s involvement in the home mortgage business and prioritize private capital, but would still allow many borrowers to get 30-year home mortgages at relatively affordable interest rates.
Congress has a brief opportunity to put this reform into law. “This might be the only real chance this decade,” said Donovan.
Many politicians, particularly conservatives, blame Fannie Mae and Freddie Mac for the housing crash and call for the agencies to be broken up. The government seized Fannie Mae and Freddie Mac from their shareholders during the financial crisis. For the last five years, they have continued to operate under federal oversight and have recently returned billions of dollars to the U.S. Treasury.
Zombie Fannie Mae and Freddie Mac may now be able to earn a profit as wards of the state, but the status quo is costing regular people when they try to get a home loan, according to Donovan. “It baffles me when people say that we should keep the current system,” he said. “Lenders still have to deal with too much uncertainty and too much red tape. . . . There are a lot of qualified potential borrowers that aren’t being served by the current system.”
Interest rates are also higher for home loans because of uncertainty about what will eventually happen to Fannie Mae and Freddie Mac. Investors demand about 20 basis points more in yield on government-sponsored enterprise (GSE) bonds compared to other bonds with a government guarantee, Donovan said. That translates directly into higher interest rates for homeowners.
A proposal for reform in the Senate now has enough cosponsors to pass through the Senate Banking Committee. Its backers hope to pass the bill out of committee with an overwhelming bipartisan majority that earns the bill a vote on the Senate floor. So far, the House of Representatives has done little more than call for the total abolition of the GSEs, but if confronted with a bill passed by the Senate, they may take it up.
Serious obstacles stand in the way. Gridlock has already stalled congressional efforts to revise the tax code and reform immigration. Congress will soon focus on fall’s midterm elections. Reform will also become more difficult as the government gets used to getting proceeds from Fannie’s and Freddie’s multibillion-dollar business.
Fannie Mae and Freddie Mac have been in limbo since 2008, when the government seized the mortgage giants from their shareholders. Fannie and Freddie kept on providing capital for home loans, under the oversight of a federal regulator. Nearly all the home loans being made today are bundled and sold as bonds by Fannie Mae, Freddie Mac, or the Federal Housing Administration.
One of the failures of the old system was that Fannie Mae and Freddie Mac had a kind of implicit, ill-defined government guarantee, Donovan said. Investors understood the government would catch the agencies if they stumbled. Even though they were privately owned companies traded on the New York Stock Exchange returning fat dividends to their shareholders, they were also “government-sponsored entities,” initially launched by the government with a public mission to provide capital for the housing market.
Bond investors were willing to accept a low yield on Fannie Mae and Freddie Mac bonds, which meant a low interest rate for borrowers. They were also willing to buy bonds backed by mortgages with long 30-year terms.
The Senate bill would shut down Fannie Mae and Freddie Mac. Under the proposal, private companies would pool home loans made by banks and issue bonds backed by those mortgages. The proposal would also create a government-run insurance fund that guarantees bonds backed by home loans that meet standards set by the fund. This limited guarantee should keep interest rates low, keep the 30-year mortgage available to borrowers, and keep home loans available even in the event of a future capital crisis.
The bill prioritizes private capital, according to Donovan. Private companies hold a significant portion of the risk of the home loans on their books and take the first losses from any foreclosures. The private companies that issue housing bonds would also pay a fee to the government insurance fund, to help pay the cost if the guarantee is ever activated.
Housing Trust Fund
The Senate proposal will also help address the worst crisis in the affordability of rental housing that the United States has ever experienced. More than half of all renters now pay a third or more of their income on rent. “Homeownership isn’t for everyone,” said Donovan. “More people are renting, demand is soaring.”
The Senate bill would provide $3 billion a year to a national affordable housing trust fund to help finance developments that build or preserve affordable housing. Housing officials in New York State, for example, would have $400 million a year to support new development.