While many politicians and housing industry stakeholders have called to end the Federal Housing Finance Agency's conservatorship of Fannie Mae and Freddie Mac recently, a recent white paper prepared by Moody's Analytics and the Urban Institute suggests that might not be such a great idea.
In the paper, titled Privatizing Fannie and Freddie: Be Careful What You Ask For, authors Jim Parrott and Mark Zandi examined the economic implications of releasing the GSEs from the FHFA's conservatorship and back into the private mortgage market, a discussion they say often takes for granted that the mortgage market will simply revert to its pre-crisis state. The authors contend, however, that economic conditions have changed in the last eight years or so that would "significantly affect how Fannie and Freddie would function as reprivatized institutions."
First, upon their release from the conservatorship, the authors say the Financial Stability Oversight Council would almost certain designate Fannie Mae and Freddie Mac as systemically important financial institutions, commonly known as "too big to fail." Such a move would require a 10 percent capitalization to withstand stress scenarios as severe as our recent economic recession.
Second, Fannie Mae and Freddie Mac would owe the government for their taxpayer bailout of $187.5 billion in 2008, at which time the FHFA took the GSEs into conservatorship. Under the current Preferred Stock Purchase Agreements (PSPAs), the GSEs were initially required to pay a quarterly dividend to the Treasury Department equal to 10 percent of Treasury's investment per year, annualized; when Treasury feared the GSEs would not be able to pay the 10 percent, the PSPAs were amended in 2012 and the GSEs were required to pay all of their profits to Treasury.
If Fannie Mae and Freddie Mac were to be reprivatized, the authors estimate they would need to increase their capitalization by at least 2 percent in order to meet that 10 percent capitalization requirement. Currently their line of credit with Treasury would provide about 5 percent capitalization and the current guarantee fee of 63 basis points would provide about 3 percent; they would need to increase their G-fees by about 27 basis points to raise the additional 2 percent capital.
The authors estimate that in the lowest-cost scenario, mortgage rates would go up by an average of 43 basis points, and in the highest-cost scenario, they would go up by an average of 97 basis points – 27 basis points for capital, 28 basis points for the commitment fee, and 42 basis points for the dividend. A number of factors could move this range of 43 basis points to 97 basis points up or down, including a change from the profit sweep to something other than 10 percent that would move the cost accordingly. If the GSEs were allowed to count future G-fees toward their capital, it would lower the cost; if the GSEs became subject to new laws and regulations from which they are currently exempt, it would drive the cost up.
"The debate over whether to recapitalize and release the GSEs into the private market is often framed as a choice of whether or not to return to a prior period in lending," the authors wrote. "For all its shortcomings, the argument goes, at least we know what to expect in the cost and availability of mortgage credit. But this is a misconception. In releasing the GSEs into the private market again, we would release them into a very different regulatory and economic environment, and they would respond, not surprisingly, by charging very different mortgage rates."