Now that the housing market has a firm foundation and is continuing its recovery, President Obama has decided to introduced legislation to reform the government-sponsored enterprises (GSE)—Fannie Mae and Freddie Mac, which has =backed 90 percent of all mortgages over the last five years.
Bi-partisan legislation called the "Housing Finance Reform and Taxpayer Protection Act" was introduced by Senators Mark Warner (D-Va.) and Bob Corker (R-Tenn.) a few months ago, if passed, will eventually replace the GSEs and create a brand new government reinsurer called the Federal Mortgage Insurance Corporation.
The GSEs would be rolled into the new entity, which would be modeled after the Federal Deposit Insurance Corp. (FDIC), within five years of the legislation becoming law.
To understand the proposal, it helps to have a little background.
Fannie and Freddie-- a brief history
Fannie Mae was formed as part of post-Depression legislation in 1938 by President Franklin D. Roosevelt and the U.S. Congress. Its sole mission focused on buying mortgages from lenders to free up money for lenders to make more home loans. In 1968, Fannie was sold to private investors.
That same year, the federal government formed Freddie to prevent Fannie Mae from becoming a monopoly. However, Freddie too was sold to private investors and taken public in 1989. The GSEs have long been the dominant players in the mortgage market—buying prime mortgages from pension funds, mutual funds and foreign governments.
Subsequently, the GSEs would package these loans into mortgage-backed-securities (MBSs) and hold them in their portfolios or sell them to investors. What made MBSs popular was the guarantee that the GSEs would pay investors if a borrower defaults on the mortgage payment.
In the early 2000s reports of problems in the GSEs surfaced, including an accounting scandal at Fannie Mae that cost the entity hundreds of millions of dollars, Around 2005, the GSEs begin expanding into buying riskier subprime and Alt-A loans in response to private companies siphoning away market share from the lucrative mortgage-backed securities market.
Following the lead on investment banks selling MBSs, the GSEs repackaged some of these risky loans and sold them to investors around the globe. This help contribute to the financial crisis that occurred in 2008. In July 2008, both GSEs owned or guaranteed $5 trillion in mortgage debt.
Later that year, the Treasury Department purchased the bankrupt Fannie and Freddie for $188 million. The Housing and Economic Recovery Act of 2008 put the GSEs under the direct supervisory and regulatory authority of the Federal Housing Finance Agency (FHFA).
The FMIC's responsibility
The FMIC would fund itself by collecting insurance premium fees on securitized loans. This money would provide the capital necessary to provide “backstop insurance” for MBSs. To be eligible for the backstop insurance, investors would have to back 10 percent of the loss on their books. The theory being they will manage risk more judiciously.
At the end of eight years, the Government Accountability Office (GAO) will conduct a feasibility study to determine the possibility of a 100 percent privatized market. Six months after the study, Congress would be obligated to deliberate on dissolving the FMIC in favor of privatization.
Many critics believe that under the the new program mortgage lenders—not borrowers—would benefit the most. Lenders will make loans to home buyers at “healthy rates” remarked Mitchell Weiss, a Credit.com contributor and financing expert. However, mortgage companies will be taking on “low risk, high rewards,” and what Weiss refers to as “the best of both worlds.”
Other are concern that the real estate industry, home builders and housing advocates will put pressure on the FMIC to lower underwriting standards to approve more home buyers. In turn, this will lead to many of the same issues that cause the mortgage and housing markets to go into freefall in 2008.