Why You May Miss Fannie Mae and Freddie Mac

A majority of Americans want government-sponsored mortgage giants Fannie Mae and Freddie Mac to relinquish their role as the twin guarantors of a majority of U.S. mortgages, according to a new poll.

The online poll, conducted by real estate news website, HousingPredictor, found that 72 percent of respondents said that they want Fannie Mae and Freddie Mac, which have cost the public upward of $180 billion since the government bailed them out in 2008, to cease purchasing mortgages from banks.

But while the public ire toward the two firms may strike few as unreasonable considering Fannie and Freddie's enormous cost to taxpayers, many Americans may not fully be aware of one possible result of their elimination, some experts say: It could put homeownership out of reach for many more Americans.

"People who have been educated on the importance of their core function," says Ken Trepeta, director of real estate services at the National Association of Realtors, "understand that if you move too precipitously here," and drastically reduce Fannie and Freddie's market footprint in the housing market, "you could have a tremendous double-dip in the housing market."

Fannie Mae and Freddie Mac currently back nearly two-thirds of U.S. mortgages, while FHA loans, which are also sponsored by the government, account for just over 30 percent of the market total, analysts say. In the wake of a housing bust that has left banks and private investors leery of buying mortgages, the three entities now underwrite or insure about 95 percent of mortgages originated today.

Housing Saviors?

Some experts say that Fannie and Freddie are the arteries of the current housing market, vital conduits that help keep credit flowing to borrowers that otherwise would have dried up during the housing crisis. Scott Simon, once managing director of the global investment management firm PIMCO, has said that Fannie and Freddie "have been the savior of the housing market" for this reason.

In their current role, Fannie and Freddie purchase mortgages from banks that meet certain standards, allowing banks to continually buy or originate mortgages. (Banks don't have to keep the mortgages on their books; they can sell them to Fannie and Freddie). That in turn, provides borrowers with access to more credit.

After Fannie and Freddie purchase mortgages, they then bundle them into packages, known as mortgage-backed securities, and sell the packages to private investors. Mortgage-backed securities involving Fannie and Freddie are attractive to investors because they pay higher yields than U.S. Treasury bonds and, like treasury bonds, boast arguably the most reliable guarantor in the world: the U.S. government. That means if Fannie- or Freddie-backed mortgages fail, Fannie and Freddie cover the losses, not the private investor. If Fannie and Freddie can't cover the losses (see: 2008's financial crisis), then Uncle Sam comes in to save the day.

Mortgage Rates Could Soar

Trepeta and other experts argue that if Fannie and Freddie left the mortgage market, mortgage rates would soar, because in the absence of government backing, private investors would only be willing to buy mortgage-backed securities -- and take on mortgage risk themselves -- for higher returns than those currently paid by Fannie- and Freddie-backed securities.

Without Fannie and Freddie, "you're not creating this private-profit, public-loss scenario," which is what has attracted private investors in the past, Trepeta says. Private investors "need a much bigger reward," which means higher mortgage rates, since monthly mortgage rates more or less constitute the yields of mortgage-backed securities, he says.

Mortgages rates currently hover near historic lows, with Freddie Mac most recently putting the average rate of a 30-year fixed-rate mortgage at 3.98 percent. But Trepeta says it's conceivable that rates could leap to 6 or 6.5 percent if the two mortgage giants exit the market abruptly.

He points to a period during the financial crisis when interest rates surged by what he says was more than 2 percent amid concern that the government might not step in to save Fannie and Freddie.

"It would have tremendous implications for access to credit," Trepeta says. "Either people would all go to FHA, which is already doing about as much as it can do, or they'd have to go to the private money with much higher rates."

In addition to raising interest rates, the absence of a robust government presence in the housing market could also slice mortgage options for homeowners, says Sam Khater, senior economist of analytics firm CoreLogic.

"If the government is not a major player in the market ... then not only can rates go up, but your product choices will change," he says. "The viability of the 30-year fixed-rate mortgage will also be at risk."

A report presented to Congress by U.S. Treasury Secretary Timothy F. Geithner in February 2011 corroborates the view that a total breakup of Fannie and Freddie would not only cause mortgage rates to soar, but also cut off mortgage options to homeowners.

While it would "drastically reduce" taxpayer exposure to failed mortgages, abolishing government-backed mortgage sponsors would result in "particularly acute costs" to credit, driving up mortgage rates and making 30-year fixed-rate mortgages harder to acquire, the report says.

How Private Capital Could Fill the Void

Not all experts believe Fannie and Freddie's dismantlement would negatively impact the market. Mark A. Calabria, director of financial regulation studies at the conservative Cato Institute, says winding down the two giants' role in the market wouldn't raise mortgage rates by more than a quarter of a percent.

He says there is "more than sufficient private capital to fill the void" left by Fannie and Freddie. "It would be easy enough for those who funded the GSEs [Fannie Mae and Freddie Mac] -- banks, insurance companies, pension funds, mutual funds, to fund the same level of mortgages," he says, referring to some common entities that invest in Fannie and Fredde mortgage-backed securities.

Calabria advocates for beginning to wind down Fannie and Freddie immediately, with the goal of completing the process within five to six years.

In a plan recently presented to Congress that is aimed at reducing Fannie and Freddie's role in the market, the FHFA, which oversees the two companies, said that "no private sector infrastructure exists today that is capable of securitizing the $100 billion per month in new mortgages being originated. Simply shutting down the enterprises would drive up interest rates and limit mortgage availability."

The plan calls for constructing a "new securitization platform" to gradually replace Fannie and Freddie that would issue "securities supported with or without government guarantees." Trepeta says that he supports some reform of Fannie and Freddie that runs along these lines in order to protect taxpayers from future losses, but questions whether a new securitization infrastructure could adequately gird the housing market without government muscle.

Follow Teke Wiggin on Twitter (@tkwiggin), follow @AOLRealEstate, or connect with AOL Real Estate on Facebook.

Houses Priced Like Average Cars
See Gallery
Why You May Miss Fannie Mae and Freddie Mac

Price: $29,900

This Two Rivers home for sale is a bank-owned property, but don’t let that deter you. Priced just under $30,000 and with three bedrooms, fresh paint, new carpets and refinished hardwood flooring, this home is a steal. But if you prefer to drop $30K on a set of wheels, a base model of the 2012 Honda CRV may be up your alley.

See the listing for more details on this home

Price: $39,900

This Kentucky home listing states the house is move-in ready, with newer hardwood floors, updated vinyl and windows. Although it’s priced below Louisville’s median home value of $86,000, the home is on the smaller side with only two bedrooms, one bath and 788 square feet of living space. For the same price, a buyer could go green with a 2012 Chevy Volt.

See the listing for more details on this home.

Price: $30,000

This two-bedroom, two-bathroom Arkansas home is a great investment opportunity since it used to be a duplex and, according to the listing, could easily be converted back. The home is situated on a larger block with a fenced yard and covered parking for two vehicles. This North Little Rock home’s automotive counterpoint? A 2012 Dodge Dakota truck, which runs about $28,000 to $32,000.

See the listing for more details on this home

Price: $24,000

Less than $25,000 is quite a deal for a home built in the past 15 years. This three-bedroom, two-bath Tennesee home was built in 1999 and features 1,200 square feet of living space as well as a two-car garage. For $25,000 in car value, how about a 2012 Toyota Camry?

See the listing for more details on this home

Price: $54,900

Priced at almost $55,000, this Wichita home is on the pricey end of our list. The adorable cottage offers two bedrooms, one bathroom and plenty of updates -- including hardwood floors, a new kitchen, windows and roof. For the same price, a 2012 Mercedes-Benz E-Class could be a classy choice.

See the listing for more details on this home

Price: $39,900

Located two hours southwest of Minneapolis, Sleepy Eye is a smaller lake town. This slice of real estate is move-in ready with newer paint, flooring and furnace. The home also has a covered porch and detached two-car garage. For the same price, you could fill the garage with a Buick Enclave, which costs the same as the home: $39,000.

See the listing for more details on this home

Price: $42,000

A two-bedroom, two-bath rambler could be the perfect place for a Florida getaway. The New Port Richey home for sale is located north of Tampa and St. Petersburg and has 1,068 square feet of living space with a formal dining room, bright kitchen with breakfast bar and outdoor patio. The potential car equivalent of the house is a Acura MDX, also priced at $42,000.

See the listing for more details on this home


See also:
No Joke: Home Prices Rising, Some Indexes Say
Best Neighborhoods 2012: First-Time Homebuyers

Read Full Story

Find a home

Powered by Zillow