Fmr. Ginnie Mae COO on privatizing Fannie Mae and Freddie Mac: Congress needs to be involved

Key Concepts

• Conservatorship: Government control of Fannie Mae and Freddie Mac.
• Mortgage-Backed Securities (MBS): Bundles of mortgages sold as investments.
• Agency MBS: MBS issued by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae.
• Explicit vs. Implicit Government Backstop: Clear legal guarantee versus market expectation of a bailout.
• Liquidity: The ability to easily buy and sell assets without affecting their price.
• Risk Weighting: The amount of capital banks must hold against assets based on their risk.
• Ginnie Mae: A government agency that explicitly guarantees MBS.
• Preferred Share Purchase Agreement (PSPAs): Agreements outlining the government's investment and rights in Fannie Mae and Freddie Mac.

Concerns About Privatization

• Juicing Returns vs. Market Safety: The primary concern is that publicly traded companies may prioritize shareholder returns over the stability of the mortgage market, potentially leading to risky behavior reminiscent of the lead-up to the 2008 financial crisis.
• Lack of Clarity: The current proposal lacks specific details about the government's role and how it will ensure liquidity and stability in the MBS market.
• Impact on Mortgage Rates: Uncertainty about the government's backstop could lead to higher mortgage rates for borrowers.

Potential Benefits of Privatization

• Separation of Roles: Privatization could separate the government's role in ensuring liquidity from the risk-taking activities of private enterprises.
• Resolution Mechanism: Private companies could be subject to resolution mechanisms like Title II of Dodd-Frank or FDIC receivership if they become insolvent.

Government's Role and Backstop

• Importance of Government Backstop: The government's explicit or implicit backstop is crucial for keeping mortgage rates low. Agency MBS trade tightly to Treasuries because of the perceived safety due to government backing.
• Impact on Investors: Without a clear government guarantee, investors would need to reassess MBS as credit investments rather than interest rate investments, potentially leading to capital reallocation and higher rates.
• Need for Clarity: The government needs to clarify when and under what circumstances it would step in to provide certainty to the bond market.

Potential Solutions

• Congressional Action: The best solution would be for Congress to clarify the government's role and put a congressional stamp on it, similar to Ginnie Mae.
• Ginnie Mae Model: The government could create a mechanism similar to Ginnie Mae, with a deep backstop in the capital stack.
• Treasury Backstop: The government could establish a strong government preferred share purchase agreement (PSPA) and an arrangement between Treasury and the enterprises to backstop them.

Ginnie Mae as an Example

• Explicit Guarantee: Ginnie Mae provides an explicit government guarantee, which is well-understood by investors worldwide.
• Stability: Ginnie Mae did not take any losses during the financial crisis because of its deep backstop in the capital stack.

Conclusion

The proposal to return Fannie Mae and Freddie Mac to the private sector raises significant concerns about the stability of the mortgage market and the potential for higher mortgage rates. The key is to clarify the government's role in providing liquidity and backstopping the MBS market. Congressional action or a mechanism similar to Ginnie Mae could provide the necessary certainty and stability. Without clear guarantees, investors may view MBS as riskier assets, leading to higher borrowing costs for homeowners.