Fannie, Freddie and U.S. Housing Finance Reform

On August 7, President Obama suggested that Fannie Mae and Freddie Mac should go out of business (see the video below), as he called

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for “a return of private capital, [to] put the risk and rewards associated with mortgage lending in the hands of private actors, not the taxpayers.”

Video: President Obama Speaks on Restoring Security to Homeownership via YouTube

Private Enterprise vs. GSE

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say, because Fannie and Freddie are private enterprises. Only in the most vestigial sense are they GSE’s (Government Sponsored Enterprises), long ago having outgrown their meager ± $2 billion federal sponsorship while issuing trillions in mortgage backed securities. Pre-bailout, their corporate shares were entirely held by private investors, and while they may carelessly have been perceived as federal agencies with meaningful federal guarantees, those things simply were not true. The truth was that, as private companies, they effectively became a duopoly in conventional mortgage finance.

Private Bailout and Public Responsibility

When the housing market crashed (through no particular fault of Fannie or Freddie), subprime and alt-A mortgages proved worthless, and in the undertow, many conventional loans ended up under water, too. Domestic and international bondholders had such huge positions in the duopoly’s bond issues that the Treasury had to bail them out, just as it had to bail out the major banks — to help avoid worldwide financial collapse.

What Reform Is the President Proposing?

None of this had anything to do with the lack of “private actors”

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in the mortgage market. Fannie, Freddie, Goldman, Lehman, Merrill, Citi, Morgan —

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every one of them was a private actor. What Mr. Obama advocated in his

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speech has already been the case for decades! The trouble isn’t that these firms aren’t private — they are. The problem is that they’re too damned big, too highly leveraged, too little regulated, and they’re incentivized in direct contradiction to prudent principles of lending and investment. The President’s speech did not seriously address any of those issues, and if ignoring the problem is his actual policy regarding US mortgage finance, then his notion of keeping the American taxpayer out of harm’s way is laughable.

What Lies Ahead for

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Multi-Family Mortgages?

The most interesting thing from LANDCO’s point of view, and something else that the President failed to address, is what will happen with multi-family lending if Fannie and Freddie are dissolved. Their overall losses from apartment loans to date have been miniscule, and ever since the housing crash, they have been the preeminent source of financing in that sector. Consequently, the terms of their bailout specifically included a multi-family lending target, and if they should disappear, then so does their bailout money. In the aftermath, leverage on apartment house loans will come down, and interest rates will probably go up — maybe a little, maybe more than a little.

Multi-family investment yields will fall. Projects other than Class A will be even more difficult to finance than they already are. So eliminating the GSE’s — if it should happen, and there’s no

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reason to suspect otherwise — should be construed as an early sell signal for multi-family. LANDCO believes we’ve already begun to see some pricing moderation, and we’ll be surprised if there isn’t more when the implications of the President’s speech have had time to sink in. That should be an opportunity for buy-and-hold investors to acquire Class B apartments with high cap rates, modest leverage (60%-70%), and an overall favorable risk-adjusted yield.