Will Frannie ever die?

  • No (67%, 12 Votes)
  • Yes (33%, 6 Votes)

Total Voters: 18

Fannie Mae and Freddie Mac (collectively Frannie) will likely survive any previous plans to close down the enterprises.

Frannie, which owns or guarantees 60% of U.S. home loans, did not need government aid for the second straight quarter. Instead, the agencies produced enough capital to repay some of the U.S. Treasury’s bailout money. Since 2008, the U.S. Treasury has given Frannie $190 billion in aid; the agencies have repaid $46 billion of this amount.

Frannie attributed the improvement in its finances to:

  • rising home values;
  • decreased loan defaults; and
  • rising purchase prices for foreclosed homes.

In addition to these factors, 59% of the loans on Frannie’s books are now post-bust loans, originated after 2009.

Frannie officials are optimistic, but have cautioned that recent improvements may be short-lived and the agencies may require additional government aid in the future. However, Fannie Mae’s chief executive officer has also noted the agencies will likely benefit the U.S. Treasury in the future, once they have been stabilized. Experts on the matter predict no action will be taken to dismantle Frannie in 2012 or 2013.

first tuesday insight

Frannie is making a killing by buying up all lender originations at par (3.6% yields) and selling them to Wall Street investors at yields just above 2.8%. Thus, mortgage rates are far higher than necessary for today’s closing, as reflected in the low homebuyer demand for purchase-assist financing.

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In a perfect world, Frannie would fade away, surpassed in efficiency and effectiveness by private mortgage insurers (PMIs). This mortgage market, however, is far from a perfect world.

Instead, Frannie dominates the mortgage market, with lenders and Wall Street investors wholly dependent on the government-sponsored enterprises (GSEs)’ parental protection.

Remove the GSE giants’ guarantees from the mortgage market and the true weakness of many home loans originated by lenders will be instantly revealed. Investors will take one look at these flimsy offerings and balk at purchasing home loans sans guarantee, likely sending risk premiums through the roof.  But this turn of events is not likely to happen any time in the near future.

Future lending standards still under development by government agencies, including the Consumer Financial Protection Bureau (CFPB) and the Federal Housing Finance Agency (FHFA), will require all homebuyers to meet an ability to repay standard, as laid out in qualified mortgage (QM) guidelines, in order to qualify for a mortgage. This standard for the homebuyer’s ability to repay will be much tighter than is currently practiced by mortgage lenders.

However, Frannie has favored an even higher lending standard for future mortgages they buy. Once officially defined and implemented, the qualified residential mortgage (QRM) will be the model used by Frannie, who will not purchase any home loans failing to meet QRM criteria.

Lenders will be required to retain a 5% stake in any non-QRM loan sold to investors. However, one of the most controversial requirements proposed thus far for the QRM is the 20% minimum down payment for homebuyers.  Pre-1980 lending fundamentals for homeownership will be re-established.

Thus, lenders will have two options:

  • satisfy the QM ability to repay standards without the QRM standards and keep 5% of the loan on their books; or
  • satisfy both the QM and stricter QRM standards and sell mortgages to Frannie.

Just imagine a world where lenders and bond market investors place their bets on mortgages due to their fundamental strength as worthy investments. This would be a positive change from the government holding their hand the whole way, allowing them to profit in good times and escape the rubble when they fail in bad times.

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If the remaining PMIs survive the ongoing deluge of defaults, if the final QM and QRM sufficiently enhance mortgage underwriting, and if investors find well-originated loans as attractive as Frannie-backed loans, then PMIs may someday seamlessly take Frannie’s place in the mortgage market. Until then, Frannie isn’t going anywhere.

Re: Fannie Mae, Freddie Mac Results May Ease Wind-Down Push from Bloomberg