Dismantling Fannie Mae and Freddie Mac would dent US housing recovery

A US Senate plan to dismantle Fannie Mae and Freddie Mac may deliver an unintended blow to a fragile housing recovery.

A draft of the measure, which Senate Banking Committee leaders released on Sunday, would replace the two financiers with a government-backed mortgage-bond insurer. It would cover losses only after private capital bears the first 10 per cent, leading to higher mortgage rates, according to Credit Suisse analysts.

The plan also would eliminate a mandate that a percentage of mortgages go to lower- and middle-income families, threatening to decrease America's homeownership rate.

Senators Tim Johnson and Mike Crapo are trying to pass the measure this year. Outside the Senate chambers, the housing market is showing signs of cooling as tighter lending and higher prices shut out increasing numbers of first-time buyers.

"It certainly slows the rate of recovery," said Kevin Chavers, a managing director at BlackRock and a member of its government relations and public policy group in New York. "It raises the question of what the implications are for the recovery as you raise costs and reduce the universe of people eligible to participate."

Fannie Mae was established in 1938, near the end of the Great Depression, to boost homeownership by making mortgages more available for low- and moderate-income borrowers. Along with the smaller Freddie Mac, created in 1970, the company bundles loans into mortgage-backed securities that are sold to investors with the support of the government.

Federal officials steadily increased the firms' mortgage origination goals during the Bill Clinton and George W. Bush administrations. By 2008, the government's mandate to reach low- and moderate-income families peaked, an aim made possible by lenders peddling riskier loans.

During the housing crash, the surge in defaults almost sunk the companies and regulators seized them in 2008. The two firms received US$187.5 billion in taxpayer funds over the next three years. And the Federal Housing Finance Agency lowered the firms' mortgage origination goals. It took about three years for Fannie Mae and Freddie Mac to earn profits again.

President Barack Obama and Democratic and Republican lawmakers want to wind down the two companies, shrink the government's influence in the market and bring in more private capital to create a less risky housing finance system.

Crapo said last week that it's important to avoid the toxic mortgages that pushed the country into financial crisis.

"There probably will be a little bit of additional cost in some senses, but there will be actually savings and efficiencies in other contexts," Crapo said. "What we're putting together is at the front end of everything a strong underwriting system so there will have to be buyers with the ability to repay."

The Senate plan's requirement that the industry absorb the first 10 per cent of mortgage losses would be a challenge for the market, Credit Suisse analysts led by Mahesh Swaminathan said in a report issued last week. Additional insurance fees for the holders of the mortgage-backed securities could lead to "sharply higher" mortgage rates, Swaminathan said.

The draft legislation calls for the dismantling of Fannie Mae and Freddie Mac over five years, which could be extended to prevent market disruptions, such as spikes in borrowing costs, according to a statement yesterday.

Rates for 30-year fixed loans climbed to 4.37 per cent last week from a near-record low of 3.35 per cent in early May. The rate reached a two-year peak of 4.58 per cent in August.

Jeffrey Gundlach, chief executive officer of Los Angeles-based DoubleLine Capital, said the 10 per cent rule would result in lenders further limiting risk.

"When you're asking or hoping for private money to take the loss risk, they're going to understandably want tighter underwriting or else the rate would have to be really high," said Gundlach, whose US$32 billion DoubleLine Total Return Bond Fund invests in mortgage-backed securities.

"At this point, tighter underwriting is more attractive than much higher mortgage rates."

Tougher credit standards and property prices, which are up 24 per cent since their March 2012 low, are already posing obstacles to homeownership. More than 40 per cent of borrowers last year had credit scores above 760, compared with about 25 per cent in 2001, according to a February 20 report by Goldman Sachs analysts Hui Shan and Eli Hackel. Consumer scores fall within a range of 501 to 990, with higher scores representing a lower likelihood that consumers won't pay back their debts.

First-time buyers accounted for 26 per cent of purchases in January, down from 30 per cent a year earlier, according to the National Association of Realtors (NAR). This January's figure is the lowest market share the NAR has recorded since it began monthly measurements in October 2008.

That's hurt sales. Purchases of homes costing more than US$250,000 rose 8.2 per cent; they fell 10.7 per cent for those worth less, NAR data shows.

The share of Americans who own their homes was 65.2 per cent in the fourth quarter, down from a peak of 69.2 per cent in 2004, according to the Census Bureau. Minority groups were heavily impacted by the housing crash: the homeownership rate for blacks fell to 43.2 per cent in the quarter from 44.5 per cent a year earlier and they are down from 50 per cent before the housing meltdown.

"You have the unusual situation that the segment of the population hardest hit by the foreclosure crisis is the one that's going to find it most difficult to rebuild in the aftermath," said Lautaro Diaz, the vice-president for housing and community development at the National Council of La Raza, a Washington-based Hispanic civil rights and advocacy organisation.

The Senate proposal seeks to bring more buyers into the market by creating affordable housing funds. The industry would pay into funds that would be devoted to ensure affordable rental and for-sale housing is available. A 0.1 per cent fee would be charged on mortgage-backed securities, which could add up to about US$5 billion a year.