No Fannie or Freddie means adios, 30-year mortgage

The Winding Down of Fannie Mae and Freddie Mac

In the housing speech that President Obama made in Phoenix at the beginning of August, the President advocated the winding down of Fannie Mae and Freddie Mac, while at the same time urging a continued path to homeownership by means of the 30-year mortgage.

There are two bills currently on the floor that offer alternate scenarios for winding down the GSEs. The Street Contributor, Brian O’Connell, provides a helpful summary of each of the two bills:

The Housing-Finance Reform and Taxpayer Protection Act of 2013: Also known as the Corker-Warner Plan, this bill proposes to eliminate Freddie Mac and Fannie Mae and generally kick direct government involvement with mortgage loans to the curb. The bill would give private lenders license to run the nation’s mortgage system — not just as loan originators, but also as issuers of mortgage-backed securities.

The Protecting American Taxpayers and Homeowners Act: Also known as the PATH Act, this mortgage reform bill ends the bailout of Fannie and Freddie, which Congress estimates at $200 billion, and phases out the entities within five years. It also calls for a reduction in the government-sponsored enterprise/Federal Housing Authority loan limits, and gives residential borrowers more mortgage loan options.

Economists argue that the winding down of Fannie Mae and Freddie Mac will lead to the elimination (or a significant decrease in the availability) of the 30-year mortgage. With no Fannie Mae or Freddie Mac in place to guarantee mortgages, the mortgage market will change. That is, without Fannie Mae and Freddie Mac, there would be no guarantee of the conventional loan. For the consumer, this could mean that the 30-year mortgage (since it would be backed by private capital) could be much more expensive.

Founder of the mutual fund Pimco, William Gross, estimates that mortgage rates would rise by 3% without government guarantees. An interest rate increase of this nature would add thousands of dollars to the cost of the 30-year mortgage, making it less appealing to borrowers.

History Repeats Itself

Many would argue that we need the GSE-backed 30-year mortgage. Before the Great Depression, mortgages were short-term, with variable interest rates and balloon payments. With a balloon payment due at the end of the term, loans were often refinanced and, as a result, there was a lot more movement in the mortgage market.

Does this sound familiar? It’s interesting to note that these types of loans are what you would think of when you think of the subprime loans of the 2000s, and what is blamed for the most recent recession. These are the types of loans that tend to facilitate more dramatic swings in the housing market. So, with the absence or decrease of the availability of 30-year mortgage, many purport that we would decrease economic stability; thus, we may see ourselves back in the recession of 2008 before we know it.

Fannie and Freddie Pay their Bills

When having a conversation about Fannie Mae, Freddie Mac, and the 30-year mortgage, you must not ignore the fact that Fannie Mae and Freddie Mac have both recorded profits in the last two years due to the housing market recovery. Additionally, the GSEs have made nearly $132 billion in dividend payments to the U.S. Treasury. (Source: Reuters)

Does housing finance need reform? Yes. Do we need to get out of our conservatorship of Fannie Mae and Freddie Mac? Yes. Do we need private capital to return? Yes. But there may be some financial benefits to keeping Fannie Mae and Freddie Mac around—not only in terms of providing a continued path to homeownership, but also with respect to providing economic stability for all.