Fannie Mae, Freddie Mac and the FHA: heroes or villains?

This week the Senate Finance Committee leaders issued new proposals for winding down Fannie Mae and Freddie Mac, while the Federal Housing Administration (FHA) announced that it would not need another bail-out this year.

FHA
With so much going on it is no surprise when we discover that we have missed a news item, but it was only while listening this week to a lecture from Yale Prof. Robert Shiller (of Case-Shiller fame and recent Nobel Prize recipient) that I discovered that the FHA did indeed receive a bail-out in September 2013 as anticipated in my article from late 2012: First Fannie and Freddie: next up FHA?

The FHA’s original role was to provide mortgage credit for low and moderate-income borrowers, but they joyfully joined the frat party that was housing in the early years of this century, including one program which allowed sellers to cover the down payment on behalf of buyers, often by inflating the price of the home.

And with the approval of Congress the FHA backed loans of as much as $729,750 in some areas. I guess it depends on your definition of low to moderate income. By the standards of members of Congress, as the chart below of their median net worth shows, I suppose somebody qualifying for a $700k mortgage would be considered low or moderate income:

Source: Center for Responsive Politics, US News

The Bloomberg article I quoted in 2012 included this wonderful passage:  “The U.S. should also consider raising the minimum 3.5 percent down payment to 5 percent or more, because research shows that mortgages with larger down payments are less likely to default.” No kidding!

During the discussion period about the new rules for mortgages Federal banking authorities proposed that borrowers needed to put 20% down when buying a home in order for the mortgage to be considered qualifying. This was watered down in the end, but I cannot help but note that while these discussions were taking place the FHA was offering loans – and still is – with 3.5% down.

Anyway, in 2013 the FHA had to draw down $1.7 billion from the Treasury in order to maintain the mandated level of its reserve funds. One of the main factors quoted by the FHA was losses on low down payment mortgages written in 2007-09.  In contrast, this week the FHA announced it would not need another draw down since its capital reserve was now up to $7.8 billion. One of the reasons for FHA’s recovery is the large increase in fees it has imposed.

Senate Banking Committee proposals for mortgage insurance
Also this week the Senate Banking Committee leaders issued a proposal calling for the replacement of Fannie and Freddie with a new system of federally insured mortgage securities in which private insurers would be required to take initial losses before any government guarantee would be triggered. It seems unlikely that any such proposal will pass Congress this year, but at least we are starting to get some proposals that show how the mortgage market may look in the future.

Fannie and Freddie “dividends” now exceed bail out funds received
Separately, the White House Budget Office said that Fannie and Freddie, which have already paid more than $185 billion in “dividend” payments on their $187.5 billion Treasury bail-out, could pay a further $181.5 billion over the next 10 years. And still owe the same $187.5 billion they started with.

This is how the Wall Street Journal described the situation this week:
“By the end of March, the two mortgage-finance companies that were seized by the U.S. in 2008 will have returned $202.9 billion in dividend payments, after receiving $187.5 billion in federal support between 2008 and 2011. The budget projections released Monday by the White House Office of Management and Budget show that the companies could return an additional $163.8 billion through the 2024 fiscal year if the bailout arrangement remains in place.

By that tally, Fannie and Freddie would return $179.2 billion more to taxpayers than they were required to borrow. Last year, the budget showed that taxpayers faced a net gain of $51 billion through 2023.

Even though both companies will have soon sent more in dividends to the Treasury than the amounts they borrow, those dividends don’t reduce the $187.5 billion in stock held by the Treasury. The terms of their government support don’t provide a clear mechanism for them to redeem those shares, and the companies are currently required to send all of their profits to the Treasury as dividend payments.

The Treasury faces lawsuits from nearly 20 investors challenging the dividend terms, which were modified in 2012. They say the government’s collection of the firms’ entire profits amounts to an unconstitutional appropriation of assets and that the Treasury and the firms’ federal regulator engaged in illegal self-dealing when it made those changes.”

Heroes or Villains?
Fannie Mae was established in 1938 as part of FDR’s New Deal to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. Fannie Mae – and later Freddie Mac – bought mortgages from banks, thereby making it possible for banks and other loan originators to issue more housing loans.

After the housing crash of 2008-10 Fannie, Freddie and the FHA accounted for some 90% of new mortgages. Over a period of 75 years one or more of these entities has provided liquidity to the mortgage market, enabling among other things banks to issue 30 year fixed rate loans. Like many others all these entities got caught up in the housing boom and like others they suffered losses.

I remain unclear as to why the solution is to dismantle Fannie and Freddie, rather than take on board the lessons learned and put in place controls to make sure that they do not deviate again from their intended aims. I fear that the answer lies more in politics – they are an easy target to blame for the crash – than economics.

If you  – or somebody you know – are considering buying or selling a home and have questions about the market and/or current home prices, feel free to contact me on 781.631.1223 or [email protected].

Andrew Oliver is a Realtor with Harborside Realty in Marblehead