The Federalization of the mortgage and housing industry is front and center in public awareness as of Thursday. I talked about this just last week in the “Credit Crisis and the Rush to Government Bailout”. This has been happening in a series of ways for the past year as the crisis began and is now reaching zenith. The Government Sponsored Enterprises, Fannie Mae and Freddie Mac are “quasi” governmental entities and their failure has always been presumed, and as you will see as time progresses, not allowed to fail as government intervenes to support them.
The GSEs
No serious discussion about the mortgage industry can leave out the most powerful players in the markets development and ongoing operations. These organizations (GSEs) securitize and/or guarantee and hold mortgage loans in the Trillions of dollars.
There are three primary mortgage related entities with direct or indirect ties to the government. They are the government owned Government National Mortgage Association (Ginnie Mae), and the Government Sponsored Enterprises which include Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Ginnie Mae is directly owned by the government and their mortgage securities are the only securities explicitly backed by the full faith and credit of the U.S. Government. They are the issuer of all types of mortgage loans however are the only issuer of loans insured by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA) and the Office of Public and Indian Housing (PIH) and loans made by the U.S. Department of Agriculture (USDA) Rural Development Housing and Community Facilities Programs.
The difference between Ginnie Mae and Fannie and Freddie (created in 1970) is that Ginnie Mae is owned and operated by the U.S. Government within the Department of Housing and Urban Development (HUD), while Fannie and Freddie are private, shareholder owned corporations that are not directly (explicitly) supported or funded by the U.S. government.
Throughout history and as current market conditions show this is a distinction without a difference. It is clearly implied that Fannie and Freddie are backed by the government.
The GSE entities are regulated by the Office of Federal Housing Enterprise Oversight (OFHEO). The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 created this regulatory oversight to address the GSEs safety and soundness which is managed by OFHEO. It also established oversight to be sure the GSEs adhere to their affordable housing requirements which is monitored by the U.S. Department of Housing and Urban Development (HUD).
To give you an idea of the influence these entities have on the mortgage market note the size of the mortgage debt outstanding estimated by the Federal Reserve at $11.9 trillion by the end of 2007. Fannie and Freddie Macs residential mortgage debt held in portfolio or securitized reached $4.9 trillion or 41.4% of the total market by year end 2007.
The GSEs’ shares are increasing as of this writing due to the fact that the secondary market has seized up to the point that more loans are being directed to government backed programs where the liquidity still exists. Total mortgage originations (dollar volume of purchased loans) market share grew from 37.4% in 2006 to 75.6% in the fourth quarter of 2007 (OFHEO Report to Congress 2008, 2008).
These companies have been embroiled in an accounting scandal, investigations of their top officers. Fannie Mae is currently under a consent agreement (ordered to take various actions) and Freddie Mac is under a voluntary agreement to fix risk management, process problems and controls.
“For the first time in four years, the Enterprises filed their annual financial statements on a timely basis. Significant progress was made in the remediation process, but OFHEO concludes that both companies remain classified as significant supervisory concerns. The primary reason for this classification has changed from previous years. The extraordinary declines in the housing and mortgage markets have greatly increased their credit and interest rate risks, which have put additional pressure on their credit management, interest-rate risk management and financial modeling processes. As you will read in this report, they have made reasonable progress in these areas as well as in governance, internal controls, systems, and operational risk management; still, they both, to a varying extent, have significant further work to finalize their remediation efforts and test those improvements(OFHEO, 2008).”
The GSEs are providing a much needed stabilizing force in the mortgage market through this crisis as was the intent of their charter to begin with. But to continue to say the government guarantee is implicit rather than explicit because it is not written that way is now proven disingenuous. The American tax payer is subsidizing these entities, according to Congressional Budget Office (CBO) study in May of 1996 then to the tune of $6.5 billion in 1995, and is certainly responsible as the lender of last resort to these massive institutions.
With the current credit crisis in full swing we have suddenly lifted the GSEs out of their supervisory arrangements, lowered their capital requirements, and loosened underwriting criteria. Congress can do this again because, again, the taxpayer is behind them shouldering the risks. The interesting thing to watch will be private industries rush to pull it all back when the market normalizes as it surely will to increase their profits. In the meantime the GSEs will have captured most of the market, taken on significant risks, and have a completely different, worsening, risk profile.
So as of today the Fed and the U.S. Treasury Department are looking for ways to prop up these entities. Conversations include opening up the Fed Discount window which is the mechanism that has allowed banks and non-banks to borrow longer term funds using riskier collateral from the Fed. The other option being discussed is the outright purchase of the GSEs debt by the Fed. Each of these options, and frankly any others, will be shifting billions of dollars of risk to U.S. Taxpayer.
With mortgage insurance companies like PMI trying to stay oxygenated with the triad of pressure from skyrocketing insurance claims, continually lowered credit ratings and thus higher capital costs (if they can even access capital with their lower ratings) and reduced revenues because of all of these, the government owned and operated FHA will be the only viable mortgage insurance program left.
Why?
Because its government owned and will be subsidized by U.S. taxpayers as losses begin to exceed claim paying capability.
The American taxpayer has been pulled into supporting trillions of dollars of high risk mortgages now and in the future.
Do you think that’s ok? Do you think they should be allowed to stand on their own or fail on their own? Do you see any alternatives to these problems?
I look forward to any comments or suggestions you might have.
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