Kroll: Here’s why the GSEs can’t (and shouldn’t) be privatized


President-elect Donald Trump’s term hasn’t even started yet, and already his Treasury pick, Steven Mnuchin, is promising the privatization of mortgage giants Fannie Mae and Freddie Mac.

However, that task might prove to be much harder than Mnuchin makes it seem. In fact, according to a research note Kroll Bond Rating Agency sent out, it’s near impossible. But if it could be done, and passed through congress, the research note explains the mortgage market would never be the same.

The note from KBRA argues that Mnuchin’s plan for the GSEs seems to infer that public ownership of the mortgage companies hinders mortgage lending, when the opposite is actually the case. Here are the examples from the note that explain how Fannie and Freddie help, rather than hinder, mortgage lending:

The GSEs provide a substantial subsidy to the housing finance market first by using the superior credit standing of the U.S. government to support the sale of securities secured by 1-4 family home loans. The USA is unique (save tiny Denmark) in offering 30-year, fixed rate, fully amortizing callable mortgage loans to homeowners.

The GSEs also act as guarantor for these mortgage securities, taking the first-loss credit risk on the underlying loans. By guaranteeing the credit risk, the GSEs make it easier for the bond market to deal with the long and variable duration risk of a 30-year mortgage.

Finally, the implicit governmental guarantee for the securities issued by the GSEs makes possible a forward, “to be announced” (TBA), market that allows for the efficient management of interest rate risk. Mortgage lenders are able to hedge their interest rate risk against a homogenous and fungible agency security in the future, usually 30-60 days forward. The TBA market greatly reduces the interest rate risk for lenders and cuts the cost of mortgage loans for consumers.

The note makes the case that without the GSEs, the mortgage market would never be the same, the TBA market would cease to exist and homebuyers would pay the price through higher interest rates.

The note explains further:

Today, commercial banks account for just half of the $10 trillion US mortgage market while non-banks account for the rest of the annual production of new loans. With no forward TBA market to hedge interest rate risk, non-banks would be marginalized and only commercial banks could hold 1-4 family mortgages, either for portfolio or sale. Banks would see a substantial increase in cost.

Of course, that increased cost would be passed on to the consumer. What’s more, costs would also increase due to investors demanding a higher return after the safety net of the U.S. government backing the mortgages disappears.

The note continues on to ask this question: Privatized into what? It further explains that if these firms act as low-risk conduits for mortgage issuance, their capital needs will be relatively small and there may be some way to create a market for private-label loans and securities. If, however, these firms take substantial balance sheet risk by holding loans and securities, issuing guarantees and purchasing mortgage-servicing rights, it is hard to see how the firms would differ substantially from existing non-bank firms.

While talk of privatization may sound good on the surface, it could actually create more problems than it solves. In fact, KBRA’s note suggests the idea will never make it past Congress. However, if it somehow does, and the GSEs are privatized, consumers should prepare to pay significantly higher interest rates as 1-4 residential mortgage could quickly become much more expensive.  

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