Will Reform of Fannie and Freddie Kill the 30-Year Mortgage?

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The sequester is all anybody wants to talk about. I get it: It’s the hip new crisis sweeping Washington. But remember Fannie Mae and Freddie Mac? You know, the once quasi-independent housing giants whose takeover by the federal government has cost taxpayers upwards of $190 billion thus far? Well, Fannie and Freddie are still owned by the federal government and, on top of that, are the only thing holding the U.S.’ badly battered housing-finance system together, as the Feds back 9 out of 10 mortgages issued today.

But Congress and the President have been so bogged down in their never-ending budget battles that we’ve heard little from Washington on this subject in recent months. Until last week, that is, when the Bipartisan Policy Center — a think tank formed by former Senate Majority Leaders Howard Baker, Tom Daschle, Bob Dole, and George Mitchell — tried to bring this very important issue back to the fore by releasing a 131-page report on the future of housing policy in America.

(MORE: Home Prices Jump Again. Are We Out of the Woods Yet?)

Their solution is to wind down Fannie Mae and Freddie Mac by slowly selling off their assets to the private sector as the economy improves. In their place, the government would create a public guarantor of mortgages, sort of like what Ginnie Mae does for FHA and VA loans now. This guarantor would not purchase mortgage-backed securities as Fannie Mae and Freddie Mac do now; rather it would simply insure mortgages in case of default, and charge a fee to do so. The BPC framework would also require issuers of mortgage-backed securities to purchase private insurance, so that the government guarantor would only have to step in in the case of a total real estate market meltdown, similar to the one we experienced in 2008.

This system is more stable than the one in place prior to the crisis because the government guarantees would be explicit, and be accounted for in the budget. Furthermore, any losses the government would have to take would be paid for in advance by guarantee fees paid by the issuing bank.

But this raises the question: Why does the government play a role in the housing market at all? After all, one of the causes of the mortgage market meltdown was quasi-governmental Fannie and Freddie taking on too much risk. And many Republicans, like House Financial Services Committee Chair Jeb Hensarling, want to completely privatize the housing finance system. Wouldn’t that make the most sense if the goal is to protect taxpayers from having to bailout out the mortgage industry again?

(MORE: Selling Your House? Choose Your Words Carefully)

Not if we want to maintain the 30-year, fixed-rate mortgage that most American homeowners have come to know and rely on. According to the report, without some form of government backstop, those types of mortgages would be exceedingly rare. As was seen during the savings and loan crisis of the 1980s, long-term, fixed-rate mortgages are risky investments for mortgage lenders to keep on their books. A bank that makes such a loan has not only to deal with the risk that a borrower may not re-pay in full, but also the risk that interest rate fluctuations impose on the investment. When interest rates rise, a bank can’t pass that cost on to borrowers because the rate is fixed. On top of that, lenders have to deal with prepayment risk, the risk that a borrower will pay back the mortgage before its due, reducing the total return of the investment.

The BPC’s position is no government role, no long-term fixed rate mortgages. So what’s the alternative? Though it may come as a surprise to many Americans, the 30-year fixed-rate mortgage is actually very uncommon outside the U.S. For all the reasons listed above, banks just don’t like to make such long commitments without being able to adjust the interest rates they charge customers, or prohibiting prepayment. In Canada for instance, the most common mortgage is a five-year fixed rate loan. These mortgages are amortized over a twenty-five year period, but the interest rate must be adjusted every five years, and there is no cap on how much interest can be charged.

This sort of system probably seems strange to most Americans, who have grown used to knowing exactly what their housing payments will be over the long term. There surely is value in having this sort of certainty, but banks don’t give it away for free. Lenders charge a premium to cover the risk they are incurring by giving such stable terms. And while it may seem to Americans that the Canadian system is too unpredictable, Canadians themselves seem to get along just fine with it, as they have home ownership rates similar to ours.

So while you may recoil at the idea of having the government involved in the mortgage market,  it appears government intervention is necessary unless we’re willing to introduce significant changes to the way the average American will finance the purchase of a home. And given how averse to change many voters in this country are, one can expect significant support for continued federal participation in housing finance for years to come.

MORE: The Best Times to Buy or Sell a House

28 comments
1neekehurley
1neekehurley

This speaks volumes about or educational system. So tired of reading about foreclosures and people being homeless. Foreclose on some of these colleges that pipe mucho dinero into their athletic programs

abrbig
abrbig

Nice job of discussing the real trade off and pointing out the Canadian example.  There's no free lunch here.  If we want gov't to take the risk, we will have to pay for it one way or another.  I would give a higher priority to paying for other needs besides subsidizing middle and upper income homeowners.

ZacPetit
ZacPetit

Well written and thoughtful article. I think full privatization is farther than our country is willing to go at this point, and I certainly don't see anything wrong with a form of insurance provided by the government - think FDIC insurance - if the public is willing to collectively chip in for it.

VMikos
VMikos

@TIME If the future of housing really does improve that should be able to help stabilize the economy right?

retiredvet
retiredvet

All mortgages need to be restricted to being issued and held completely by local banks and credit unions period. No slice and dice into fantasy securities. These are real property loans. Real estate is local. Making confetti of these loans like what happened in the great financial lunacy needs to be outlawed!

tomsquawk
tomsquawk

"one of the causes of the mortgage market meltdown was quasi-governmental Fannie and Freddie taking on too much risk." one of, maybe the. were sr managers bozos, backslapping and high fiving fools, unaware of risk? wonder how they were compensated.



AllenSanford
AllenSanford

30yr. fixed rate mortgages were tied to jobs that had 30yr. retirement schedules. Those jobs are obsolete as is the concept of the 30yr. mortgage. Taxing income is also obsolete. Go online with the question, Real Estate Crisis or Government Sanctioned Racketeering?...Sign the petition and read the website that is recommended. Give them a like and pass the information along.

hanrod1
hanrod1

Yes, and it is necessary for another reason as well; FHA and VA government back mortgages are regulated so that, like much like in Canada, banks and private mortgagors cannot play games with fees, costs and interest rate scams, failures to disclose properly, etc; which "creative" tactics banks and other U.S. financial organizations will use to every extent not prohibited by law. A private, non-governmental, mortgage system, sure, right along with a private-only health care system and "retirement" system too. We can also sell the government itself to private interests, if we haven't already. 

NvMortgageMan
NvMortgageMan

While a well-written article, it completely whiffs on the main cause of the Great Heist, namely Credit Default Swaps.  While everyone was drinking the Jones Juice, the actual perpetrators of the wholesale transfer of wealth worked behind the scenes creating the greatest Ponzi scheme of all time.

abingos
abingos

Please note that even Canada has its own version of Fannie & Freddie. Its called CMHC, and you can see the website here: http://www.cmhc.ca/ .

Note, also, that Government intervention in the Canadian real-estate, especially since 2004, has lead to a near-real estate bubble, with average prices in cities like Toronto and Vancouver hovering around the one million dollar mark!  Nobody knows if these prices are sustainaible. They have certainly outstripped income, so most people who are paying attention are nervous about the market. The Government too is nervous. It has recently injected aggresive policies that are designed to cool the housing bubble.

My take? Government intervention in the housing market is almost certainly evil.  it leads, at best, to to unrealistic bubble prices, ultimately making it harder for lower-income citizens to purchase houses or to retain them after they purchase them. We need a reality check, aka an unrigged free market.  Everyone, including Mortgage Lenders,  should take FULL responsibility for their business decisions, and it is only when Banks and Lenders are COMPLETELY on the hook for the loans they write that they will be make sensible decisions. They will not write a ridiculous 700K cheque for a house that's only worth $100K if the Government did not have their back.

jmac
jmac

Remember Fanny Mac - or remember  J.P. Morgan?   "It’s worth remembering the synthetic derivatives that helped cause the 2007/2008 financial crisis and the massive loss at JPMorgan Chase are fairly new.  There was a time when the world worked just fine without them.

Ironically the derivatives in the spotlight right now were started by a group of young JP Morgan bankers gathered for a conference in Boca Raton, Fla. in 1994.  They were there in part to come up with better tools to manage their risk.  They created this market largely to benefit themselves."

feifei_sun
feifei_sun

@NateRawlings @crobmatthews do you see why I ask Chris a million questions now??

BobShafer
BobShafer

So I just Refi'd at 3.25 for a 30 year fixed, so how exactly is Freddy going to sell my mortgage to a bank?  Especially since inflation eats up most of that interest they would be earning?  If I were the bank CEO, I would simply say Thanks but no thanks I can make more money investing elsewhere.

antonmarq
antonmarq

Sounds like the old shell game that's been going on for years to protect the con artists, our government. 

bryanfred1
bryanfred1

The problem wasn't Fannie and Freddie's involvement per se (granted a public company profiting from a government backstop always creates hazard); it was that in return for ongoing taxpayer support Congress mandated an ever-larger portion of their portfolios be dedicated to mortgages supporting  'affordable housing,' ultimately to the point that they swamped the natural market.  By the time of the crisis more than half of all new mortgages backed by F&F were subprime in some regard, and originators knew literally any piece of junk mortgage they could sign up would be accepted.

MarkTenneyNewMa
MarkTenneyNewMa

What were mortgages like in the US before FNMA, FHLMC?

hanrod1
hanrod1

@abingos You have a point, although there neither is nor likely ever will be a truly "...unrigged free market...", in mortgages or any other financial products. If the government is not doing the "rigging" the big private firms will do so, even colluding as necessary to accomplish it. True, the availibility of good 30 year mortgages props up the, unnecessarily high, price of housing, but so do several other factors, including particularly the tax-deductibility of mortgage interest and taxes (I'm for dropping that, as it mostly helps the better healed). How about disallowing the mortgage and tax deductions AND depreciation of SINGLE FAMILY homes used as rentals, i.e. as "businesses". That would put many "on sale", and drive the prices down. Of course, any of these actions, including privatizing and shortening mortgages, would do some of that; BUT THEN just what do you think THAT would do to the overall economy, particularly if implemented quickly? The concept of "free markets" is only a failed, dying, concept, in the face of our "brave new world" of multi-national corporate hegemony and globalism.

jmac
jmac

Just in case any one reading the article might think that the Republican head of the Financial Services Committee, Jeb Hensarling, Texas, is a 'moderate' - he hit the Federal Reserve over their latest stimulus due to his fear of high inflation and he voted against Boehner's fiscal cliff deal on Jan 1st - along with his pals Bachman, Louie Gohmert and Darrell Issa.   He's worse than Paul Ryan.  


NateRawlings
NateRawlings

@feifei_sun @crobmatthews He's our resident explainer in chief.

rtb24
rtb24

Your loan along with thousands of others are bundled together into something called a mortgage backed security.  The value of the security are the cash flows from the principal and interest payments people like yourself make every month.  Rather than wait 20 or 30 years for that cash to come in, they take that bundled security and sell it to investors and use the cash to buy more loans from the lenders.  Then the lenders use the cash from Fannie and Freddie to make more loans to homeowners.

jmac
jmac

@antonmarq  Your comment is why I so object to this column.  You've read it and determined it was the government that failed and was responsible for the meltdown.  It was the banks.   Matthews writes:   "many Republicans, like House Financial Services Committee Chair Jeb Hensarling, want to completely privatize the housing finance system. Wouldn’t that make the most sense if the goal is to protect taxpayers from having to bailout out the mortgage industry?" 

  Taxpayers bailed out the corrupt, gambling banks that were betting that their toxic loans would fail.   Federal prosecutors are suing the banks that made the fraudulent loans.  While everyone should take out a 15-year loan (anyone who sits down and can amortize  knows that's the only way to go - and if you pay extra on that 15-yr loan make sure you watch your creditors closely because they'll cheat you) , the bottom line is the meltdown was due to the big banks.  They're the con artist.  


jmac
jmac

@bryanfred1 McClatchy:  Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.


Read more here: http://www.mcclatchydc.com/2008/10/12/53802/private-sector-loans-not-fannie.html#storylink=cpy

Christopher_Matthews
Christopher_Matthews moderator

@MarkTenneyNewMa Prior to heavy federal involvement in mortgage finance (i.e. the 1930s) mortgages were typically issued with terms of three to ten years, with the full principal owed at the end of the term in a single "bullet" payment. Homeownership rates were far lower than are today, around 45%%.

bryanfred1
bryanfred1

@jmac @bryanfred1 I'm not sure what you and I are saying is all that different.  Congressional mandates by 2008 required nearly 60% of new mortgages acquired or backed by F&F to be in support of affordable housing.  That's an insane figure, but what did the politicians care?  Housing prices had never gone down year to year and besides, it wasn't their money.  It was ours.

But prior to 2000 there effectively was no subprime market - it was an animal created almost entirely by Congress and HUD in support of the affordable housing ideal.  Subprime provided better yields than traditional mortgages, so it's not shocking private investors wanted in.  Your point was that by the end private markets were investing more, but that was on a greatly expanded market.  F&F by virtue of its running head start still held the majority of subprime mortgages (and still does).

jmac
jmac

@bryanfred1  "After all, one of the causes of the mortgage market meltdown was quasi-governmental Fannie and Freddie taking on too much risk."

   While improvements to the structure of the GSEs can surely be justified, it would be a mistake to assume that simply reforming the GSEs, without reforms to the private-label market, would prevent another crisis."

-----------After all, the main cause of the meltdown was a breakdown in regulations and the banks playing casino with our money  ------------------