Finance: GSE Reform-What’s Next

GSEs on better footing as reform process drags on

By Poonkulali Thangavelu, Contributing Editor

Fannie Mae and Freddie Mac have done considerably better than expected since going into government conservatorship in 2008, even as the Federal Housing Finance Agency (FHFA) has attempted to restrict their activities.

The recent improvement in the housing market means that the two government-sponsored enterprises have reported robust net incomes ($84 billion for Fannie Mae, and $48 billion for Freddie Mac) for 2013. The strong results have also been positively influenced by favorable effects from tax benefits and legal settlements.

While these positive effects will likely not continue to favorably impact earnings going forward, Fannie Mae and Freddie Mac have also, taking into account dividends payable through March 2014, given back more than $200 billion to the government, compared to the $187 billion in taxpayer support they have gotten.

However, going into the sixth year of government conservatorship for the two, the future of these GSEs is still up in the air.

Michael McRoberts, head of conventional multifamily GSE lending at Prudential Mortgage Capital Co., says, “At the end of the day, the solution needs to be that you need to have private capital at some level to protect the federal government from having to step in and cure the problem at a time of stress. If that means Fannie and Freddie can reconstitute in a different name or different format, so long as there’s capital in front of it, that’s fine, but it’s a lot more complex than that.”

Call for footprint reduction didn’t impede the GSEs

Fannie Mae and Freddie Mac continue to support the multifamily niche by providing funding, particularly in second- and third-tier markets where life insurance companies and banks are loath to venture.

For 2013, Fannie Mae provided more than $28 billion in multifamily financing, while Freddie Mac’s multifamily activity was about $26 billion.

And this came about even as FHFA, under acting director Edward DeMarco, directed the GSEs to cut down on their multifamily lending volumes by 10 percent from 2012 levels.

Considering that the FHFA directive came in March 2013, and was retroactive to the beginning of the year, the GSEs had to restrict some of their business activity for the year, creating uncertainty in the marketplace. In fact, they had to pull out of the market last summer in order to conserve some of their activity for the fall, Doug Bibby, president of the National Multifamily Housing Council, recounts.

As of March, the FHFA, under its new director Mel Watt, had not yet come out with its 2014 position on its proposals for Fannie Mae and Freddie Mac’s footprint reduction.

Mitchell Kiffe, co-head of production, CBRE Capital Markets, says, “The early returns­—[from] people reading the tea leaves—are that director Watt will take a different approach than acting director DeMarco was taking. The final outcome of reducing taxpayer exposure will be the same, but maybe director Watt takes a longer view of the transformation.”

In addition to the directive for the GSEs to cut down on their lending volume, the FHFA has also explored the possibilities for other limits on their business activities, such as cutting down on certain loan products and types of properties eligible for GSE financing.

Bibby is opposed to this sort of micromanagement. He says, “If you want to restrict Fannie and Freddie’s business, use price. If you don’t want them competing for ‘A’-type properties in ‘A’-type markets, then make them uncompetitive with the others who are proposing to move capital to those areas. We were against this arbitrary number (the 10 percent volume reduction) to start with. And we are opposed to a continuation of that. It’s unclear whether the FHFA will take a similar action this year, although I hope not.”

It’s in the “A”-type gateway urban markets, such as New York, that the GSEs face the most competition from other lenders such as life insurance companies and banks. When it comes to the less sought-after “B” and “C” markets, such as Detroit and Cleveland, and more rural markets, it’s another story. In these sorts of markets, the Commercial Mortgage-Backed Securities (CMBS) conduits were the GSEs’ only competitors during the boom years. And CMBS is still not back in full force, although issuance has been picking up in the last few years, and topped $80 billion in 2013.

Reform process still not clear

Given the fickle presence of private lenders, who tend to be more active during good economic times, and their tendency to avoid the smaller markets, there remains a need for some kind of government role in housing finance. That’s why a proposal from Rep. Jeb Hensarling (R-Texas), which envisages phasing out the agencies in a shorter time period and introducing a largely private-capital based system, hasn’t gained much traction.

On the other hand, a proposal by Senators Bob Corker (R-Tenn.) and Mark Warner (D-Va.), the Corker-Warner bill, calls for the government to have an ongoing role but with private capital in a first-loss position. This is the one proposal industry participants see as gaining the most traction. This version also calls for money raised from mortgage insurance premiums to be put into an FDIC-like insurance fund that will be available to cover future losses.

Bibby says, “We think that’s a better way to approach this issue, without removing the government altogether, which would be catastrophic. It would be to put the government in a true catastrophic loss position behind the private capital.”

Unless the Corker-Warner bill goes through the Senate Banking Committee by the first quarter of 2014 though, it is likely that politicians’ attentions will be diverted by the upcoming elections for Congress. Bibby expects that in that case the uncertainty about GSE reform could stretch into 2015.

The Obama administration hasn’t yet come out with a concrete stand on GSE reform, and has been working more behind the scenes, except to make it clear that the government will not be in a first-loss position in future.

Fannie and Freddie’s future

This means that a government backstop for Fannie Mae and Freddie Mac is a likely possibility, whatever the reform process comes up with.

The two could still exist as private entities without any government sponsorship, and their recent good performance has made them look more viable. However, in that case their role might be curtailed to a significant extent.

According to Kiffe, “Both of them have addressed that question. Their answers were a little different. Fannie’s answer was more pessimistic [regarding whether] they could have a real place in the market in a significant way. Freddie’s answer was similar, but I think they were a little bit more optimistic that they could be a significant player in the mortgage market without access to a federal guarantee.”

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