Get ready to pay more for a mortgage.
Five years after the housing market imploded, Congress has revived a debate about what to do with Fannie Mae and Freddie Mac, the government-backed mortgage lenders that taxpayers bailed out in 2008.
Given the thorny issues surrounding the housing collapse, Fannie and Freddie’s role and the decline in U.S. home ownership, though, don’t expect to see big changes in the mortgage market anytime soon.
There’s no shortage of proposals to put Fannie and Freddie out of business. In the House, Republicans want mortgages funded pretty much entirely by private investors. In the Senate, a bipartisan bill would keep the government involved with a more limited mortgage guarantee designed to keep mortgages more widely available and affordable than those backed only by private investors.
In any case, removing Fannie and Freddie guarantees will likely raise the cost of getting a mortgage because private investors would have to bear a bigger share the cost of defaults.
Why do we need Fannie and Freddie in the first place?
Fannie and Freddie have deep roots in the U.S mortgage market that stretch all the way back the last hosing collapse in the Great Depression. After private lending all but dried up, the government stepped in to buy mortgages, which freed up cash to finance the next home loan. The system worked fairly well for more than 50 years before a manic wave of bad lending sank the mortgage market.
Today, private lending has once again all but shut down. Without Fannie and Freddie - or some government-backed alternative like them - the housing market would likely grind to a halt.
During the housing boom, more than 60 percent of mortgages were funded by investors in the so-called secondary market without government backing. Since then, private investors have all but fled the mortgage finance market. Nearly nine out of 10 mortgages written today are backed by Fannie or Freddie.
How did Fannie and Fred get into so much trouble?
The simple answer is that they tried to compete with Wall Street. During the housing boom, mortgage brokers and Wall Street bankers cooked up a financial model that churned out hundreds of billions of dollars in profits funding loans for borrowers who couldn’t pay them back. Fannie and Freddie – which are both owned by shareholders – followed Wall Street deep into the mortgage mess to capture some of those profits for shareholders.
As any kid with a little extra lunch money will tell you, lending to people who can’t pay you back turned out to be a huge mistake. When the dust settled, Fannie and Freddie were broke. To keep them going, the government took them over and fed them $187 billion in cash.
Yikes! Are they still siphoning money from the Treasury? How much is all this costing us?
Fortunately, the bleeding stopped in March, 2011. Since then the money has been flowing the other way.
As the housing market has recovered, so have Fannie and Freddie’s finances. That’s because the two major forces that swamped them with losses – falling home prices and rising mortgage defaults – are now helping to boost profits. On Wednesday, Freddie Mac said its second-quarter profit jumped 65 percent to $5 billion, its second-largest ever
Since 2011, Fannie and Freddie have been sending profits back to the U.S. Treasury.
Since returning to the black, Fannie and Freddie have paid nearly $132 billion in dividends back to the government. In other words, if the housing recovery stays on track, Fannie and Freddie will have repaid the bailout within a few years and keep generating a reliable stream of cash for the federal government.
So why not just keep them going?
First, everyone wants to avoid a repeat of the Fannie Freddie bailout. Some – including President Obama - argue that the risk of that happening remains as long as Fannie and Freddie are writing new loans with taxpayers on the hook for any losses.
Though they’re profitable, Fannie and Freddie still cost the government billions more in what amounts to a subsidy for covering the risk of future defaults. It’s not unlike letting an insurance company collect premiums on a policy that it then hands over to the government when the policyholder files a claim for losses.
What are Congress and the White House proposing to do about it?
The devil is in the details – which are still far from finalized.
The goal of all of these plans is to shift more from the government to private lenders. But under the current rules, there are very few private lenders willing to finance home mortgages. The only way to get them back into the market is to offer them great financial incentives – which means higher cost to borrowers.
That’s going to make it very hard to pull off one of the other major goals of Fannie and Freddie reform: keeping mortgages widely available and affordable, especially for first-time buyers.
Housing advocates argue that these proposals don’t go far enough in making sure that home ownership – which has fallen to a rate not seen in 17 years – doesn’t fall further.
“Home ownership for the middle class or those entering the middle class is still - despite the financial crisis – the most significant way of developing inter-generational wealth,” said David Berenbaum, chief program officer at the National Community Reinvestment Coalition. “We need to be sure the new system sustains that.”
All of these proposals still face a major hurdle. Until there’s much stronger evidence that private mortgage financing of mortgage is coming back, any effort to wind down Fannie and Freddie would throw cold water on a housing recovery that has only recently begun to pick up momentum.
And no member of Congress – let alone the president – wants to run the risk of having their name on a law that slows or reverses that recovery.