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What could replace Freddie Mac and Fannie Mae?


What would a future without Fannie Mae and Freddie Mac look like? Almost 80 years after Fannie’s creation, that question is being pondered in offices ranging from Miami construction trailers to the White House.

The two government-backed mortgage giants have become twin pillars of the U.S. housing market. By buying up mortgages from banks and private lenders, they provide liquidity that keeps lenders lending. The fixed-rate 30-year mortgage, which most countries don’t offer and which allows many Americans to afford homes, exists largely because of their subsidies.

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But their life span may be limited as the U.S. government and private investors — including Miami’s Fairholme Funds — battle over their future. A key ruling in a lawsuit over whether the government has the right to wind down the twins may come as early as this month.

The government’s position: A future housing crisis could leave taxpayers vulnerable. While the two companies are privately owned and publicly traded, they are government-sponsored enterprises, or GSEs, backed by the government.

We do not have enough capital today.

Timothy Mayopoulos, Fannie Mae CEO

The government argument is based on the Freddie-Fannie collapse during the last housing bust, when the U.S. Treasury Department stepped in with a $187.5 billion bailout. While the companies are once again making money, the federal government shows no desire to return them to independent control, freeing them from a conservatorship that began in 2008.

In response, shareholders have launched a series of ongoing lawsuits, spurred by a 2012 announcement by the U.S. Treasury Department that it would take Fannie and Freddie’s profits for itself. Treasury has said its extraordinary commitment to the GSEs entitle it to repayment and that it is acting within the 2008 bailout law.

But the shareholders argue the government’s profit sweep violated their rights and nationalized the companies.

The stalemate has left the companies in a zombie state, drained of their capital by the government and lacking the resources to back anything but the safest mortgages.

“We do not have enough capital today,” said Timothy Mayopoulos, CEO of Fannie Mae, in a speech earlier this year. “While every other financial institution has been increasing its capital...ours will decrease to zero by 2018,” thanks to rules issued by Treasury in 2012.

As journalist Bethany McLean wrote in her 2015 book, “Shaky Ground,” Freddie and Fannie are “the last major financial institutions to remain in post-crisis uncertainty. . . . They have managed to achieve a worst-of-both worlds status: too political to be financially secure, but too financially insecure to accomplish their political mission.”

Meanwhile, the American Dream could be slipping away. In the second quarter of 2016, the U.S. homeownership rate fell to its lowest in 50 years — 62.9 percent, according to U.S. Census figures. Minorities, in particular, have struggled. The black homeownership rate stands at 41.7 percent. For Hispanics, it’s 45.1 percent.

A hodgepodge of solutions

Everyone agrees something has to be done — and that it’s crucial to preserve affordable mortgages. But few agree on how to do it.

The Obama administration advocates winding down the companies, and has called for comprehensive housing finance reform, which would involve a complete overhaul of the current system.

Congressional gridlock all but guarantees that resolution will fall under the next president’s watch. A variety of reform bills have been proposed in Washington, D.C., where they’ve languished.

More right-leaning proposals would eliminate Freddie and Fannie entirely and replace them with the private market.

$187.5 billion Size of 2008 bailout for Freddie and Fannie

On the other end of the pendulum, many of the Fannie-Freddie investors support a program of “recap and release” that would send the companies back to business as usual, but with protections meant to avoid the excesses that contributed to their struggles. (Those no-nos would include creating large internal investment portfolios that could sour during a crisis and lowering credit standards so that buyers without sufficient savings could buy homes.)

That kind of solution is opposed by the administration. Antonio Weiss, a Treasury official, called such an approach “misguided” in a Bloomberg column.

But Phil Stein, an attorney at Miami’s Bilzin Sumberg who represents financial service companies and lenders, said Freddie and Fannie serve a valuable purpose as currently constructed.


“Although credit may be loosening somewhat, there has been a real hesitation on the part of major banks to dive back in with gusto to lending with borrowers,” Stein said. “The fact that Fannie and Freddie are around and reasonably healthy and buying a lot of mortgages provides some cash flow to those reluctant banks and makes them somewhat more willing to open up the spigot and deal with borrowers.”

His view: “In the absence of Freddie and Fannie, the private lenders in what is still a volatile market would revert to their positions of being reluctant to make a lot of new loans.”

If they threaten liquidity, reforms to America’s housing finance system could pose a threat to the real estate industry, say some developers. And with Miami’s heavy economic dependence on real estate and construction, a threat to the industry is a threat to local financial well-being.

For Sergio Pino, founder of Century Homebuilders, 30-year fixed mortgages are the bedrock of business.


Pino currently is building 250 single-family homes in West Miami-Dade priced between $450,000 and $600,000. They’re at the high end of what’s attainable for a successful upper-middle-class family. (In Miami-Dade and most other counties, Fannie and Freddie only guarantee loans up to $417,000.)

Even so, almost no one is paying cash. Pino said 90 percent of his buyers use fixed-rate 30-year mortgages to close.

He’s heard the chatter about Freddie and Fannie — but doesn’t believe lawmakers would go through with reforms that could make lending more expensive.

It would kill the market.

Sergio Pino, developer

“It would kill the market,” Pino said. “It would put a lot of people out of the opportunity to buy a home.”

Other real estate industry players agree that the GSEs play a crucial role.

In Broward County, developers have obtained initial Fannie Mae approval for the Metropica condo project. That means lenders can offer mortgages to buyers of Metropica condos knowing that Fannie Mae will insure the loans.

“It makes the units more accessible for domestic buyers,” said Joseph Kavana, one of the developers. “They know that they can buy a $500,000 unit for $80,000 down. For those buyers it’s an incredible advantage. . . . It helps homeowners and it helps the project.”

Longtime developer Armando Codina, whose current projects include the mixed-use Downtown Doral, takes a slightly different view.

“If there were no mortgages or a five-year mortgage with a floating rate, that would hurt the industry. . . . [But] it doesn’t have to be a 30-year mortgage.

“Thirty-year fixed rate mortgages have been good for buyers and the home-building industry, but that may very well have to change. The rate risk associated with 30-year fixed mortgages is not only large, but also impossible to truly measure, and therefore not sustainable. In my opinion, Freddie and Fannie need to be retooled and updated.”

Codina noted that we now have technology that would enable Freddie, Fannie and other lenders to separate the credit risk from the interest risk, thereby potentially mitigating rate risk.

“What’s most important to buyers is an affordable monthly payment. Today, when few buyers live in the same home for 30 years, a shorter-term mortgage — for 10 or 15 years — make more sense.”

Codina suggests shorter-term loans that still have a 30-year amortization and a fixed monthly payment for a set number of years before the rate could rise; all loans could be paid off early without incurring a penalty.

For example, it might be a 10-year mortgage whose monthly payments would be calculated at the same rate as a 30-year loan for the first five years before the rate could increased. If the homeowner chose to pay off the loan early — for instance, if the home were sold — they would not incur a financial penalty.

Buyers would then have more equity in their homes, while private financial institutions would have an incentive to lend — something that’s missing with today’s historically low mortgage rates of 3.25 percent . But lending standards — creditworthiness — would need to remain high.

“Right now money center banks are making tremendous profits with little or no risk.”

‘A systemic risk’

Boosted by high demand for homes, Freddie and Fannie have returned to profitability. Since receiving their $187.5 billion bailout, the GSEs have paid the treasury department roughly $250 billion in dividends.

But some analysts argue that despite an uptick in market conditions, Freddie and Fannie will always leave taxpayers on the hook in an economic crisis.


Another idea for reform backed by former White House official Jim Parrott and several prominent economists would eliminate the GSEs and create a new government mortgage corporation. The new company would act as a lender of last resort, ceding most of its market share to banks and financial institutions, and receiving an explicit guarantee from the government.

In such an arrangement, the argument goes, private firms would bear most of the risk and taxpayers would only have to step in during a major economic crisis.

It is all too easy to take false comfort in the current status quo in the mortgage market.

Jim Parrott, former White House advisor

“It is all too easy to take false comfort in the current status quo in the mortgage market,” Parrott and his co-authors wrote in an Urban Institute paper. “Home sales and house prices continue to trend upward in most of the country, and lenders have a market into which to sell their loans. But the housing finance system we have today is unhealthy and unsustainable; mortgage credit remains overly tight, taxpayers remain at risk, and the system lingers in a dysfunctional limbo. If we do not take seriously the need for reform until there is a crisis, we will be forced to undertake a remarkably complex and important effort when we are least equipped to handle it.”

Bipartisan bills — including a proposal from Sens. Mark Warner, D-Va., and Bob Corker, R-Tenn., and another from Sen. Mike Crapo, R-Idaho, and then-Sen. Tim Johnson, D-S.D. — trend in that direction. But they haven’t gone anywhere. Fannie and Freddie are complicated beasts — and politically they can be toxic.


Even some people who’ve been helped by the 30-year mortgage don’t see value in the companies.

In 1984, Robert Black, a research meteorologist, took advantage of the low rates offered by a 30-year mortgage and a Miami-Dade County program for first-time home buyers to purchase a $75,000 home in South Miami. He put 10 percent down.

“It was pretty close to the American dream home,” he said. “I wanted a two-car garage and we couldn’t afford it at the time.”

He and his wife still live there. It’s where his children grew up.

But while he recognizes the need to help out first-time home buyers, he’s not a fan of government involvement in the private market.

“I don’t think it’s that bad a deal if Freddie and Fannie go the way of the dinosaurs, as long as other programs that help out first-time buyers still remain,” Black said. “Government influence into the marketplace always produces distortion because they’re going to favor their cronies. . . . There should be a private-market solution.”

$250 billionDividends paid by GSEs to U.S. Treasury Department

Analyst and author Josh Rosner sees a different path forward. He thinks the housing market is so important to social welfare and the economy that it should be regulated as a public utility, like gas, water and electricity. Freddie and Fannie would remain privately owned and publicly traded. But their rates would be set by an independent board. Such a change would require an act of Congress.

“If you were to set up a public utility commission, you would take the politics out of it,” Rosner said. There’s a recognition of the social need for housing mortgage loans to be able to be made in good times and bad. . . . If you are taking the strategy of the administration, essentially what you’re going to do is give the secondary mortgage market to the primary big market players, especially the four big banks, which is going to recreate the risk we had before the crisis.”

Great Depression roots

A history refresher can help in understanding Fannie and Freddie.

Congress created Fannie (properly the Federal National Mortgage Association) in 1938 to stabilize the housing market during the Great Depression.

When the economy suffers, lenders don’t dole out cash. Before the Great Depression, home buyers had to use short-term, five- or 10-year loans with high down payments, risking their equity in the event of economic turmoil. Many lost their homes when their mortgages came due during the Depression because lenders wouldn’t refinance.

But Fannie’s willingness to buy up mortgages meant banks could keep lending. The government wanted to ensure that people could still buy homes or refinance even in bad times. By creating a national mortgage market, it also smoothed out regional variations in lending.

Fannie Mae was created during the Great Depression to help owners keep their homes and to encourage banks to lend during tough times.

Freddie (the Federal Home Loan Mortgage Corporation) was created in 1970 to compete with Fannie, which had been re-legislated into a publicly traded, privately owned company two years earlier. Because of their size, they essentially have a duopoly on the secondary mortgage market. Although Freddie and Fannie became publicly traded, they were implicitly backed by taxpayers, earning them the official title “government-sponsored enterprises,” or GSEs, and helping them lower their own borrowing costs.

An implicit guarantee means that it is assumed, but not required, that the government would bail out the companies. Such an assumed guarantee lowers borrowing costs, giving Freddie and Fannie an advantage over private competitors.

Some analysts believe that an explicit, cut-and-dry guarantee — a firm commitment from the government for a bailout — would work better. A paper by economists at the Federal Reserve Board argued that an explicit guarantee would allow the government to price the cost of its backing, prevent market distortions and protect taxpayers.

Whatever way the GSEs are backed, their presence ensures the viability of the fixed-rate 30-year mortgage. Without that, many fear, banks will give up long-term, fixed-rate loans that risk the profits resulting from an interest-rate hike, and focus instead on shorter-term, adjustable-rate loans that bring guaranteed profits.

Because Fannie and Freddie package up, or securitize, large batches of loans and then sell them to investors, the banks’ profits are guaranteed. The GSEs have come to dominate this secondary mortgage market, responsible today for $5.7 trillion of mortgage-backed securities — roughly two-thirds of the market. Private-label securities account for just $500 billion.

The proposals to wind down Freddie and Fannie depend on the private sector increasing its market share in a big way. Whether non-government lenders would do so remains a question.

But, said David Stevens, president and CEO of the Mortgage Bankers Association, “there has to be structural reform before the market can function. . . . And we have to guarantee that the 30-year mortgage continues to exist.”

There has to be structural reform before the market can function.

David Stevens, Mortgage Bankers Association

Stevens said uncertainty surrounding Freddie and Fannie, as well as high regulatory costs, mean private companies won’t get into the mortgage securities business as it stands. “There’s no trust in the market and no liquidity,” he said.

Any reform will be a long, hard slog, according to Stevens. But whatever system emerges must ensure a level playing field for small community banks, credit unions and independent mortgage providers, he said.

“Before the GSEs failed, they would give special sweetheart discounts to the biggest banks in exchange for market share,” he said.Small firms couldn’t compete. That really contributed to a large concentration of risk in a small number of institutions.”

Even with a level playing field, firms would have to be willing to take a lower rate of return on 30-year mortgages than they might achieve with shorter-term loans.

“There’s just no money in it,” said John Warren, CEO of South Carolina-based Lima One Capital, which has an office in Miramar. The company lends to investors, including high-rate, short-term loans for home flippers, but not owner-occupiers.

Said Warren: “ If you do away with Fannie and Freddie, you’re still going to have all the regulation.”

Nicholas Nehamas: 305-376-3745, @NickNehamas

This article contains information from the Public Insight Network, an online community of people who have agreed to share their opinions with The Miami Herald.

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