Fannie-Freddie Debate Revived by Mnuchin Comments on Trump Plans

(Bloomberg) -- The U.S. mortgage market could soon undergo its biggest change in decades.

Fannie Mae and Freddie Mac shares soared 46 percent Wednesday after Steven Mnuchin, President-elect Donald Trump’s pick to become Treasury secretary, said the new administration would act quickly to end federal control of the two mortgage-finance giants. Some shareholders speculated that his comments might mean that the administration could move to recapitalize and release the companies into the private market, potentially restoring some profits to private shares.

It’s unclear what Trump or Mnuchin want the housing-finance system to look like, but the comments in a Fox Business television interview still tee up renewed debate over what should happen to Fannie Mae and Freddie Mac. A conclusion to the saga would have major ramifications for mortgage rates, home prices and loan availability, as well as for hedge funds and other investors who bet on the companies when their share prices were at rock bottom.

“In the wake of the financial crisis, there is bipartisan agreement about the need to structurally reform Fannie Mae and Freddie Mac to prevent another housing crash,” the transition team said in an e-mail to Bloomberg News. “Government ownership of these entities creates a systemic risk by encouraging and subsidizing risky behavior on Wall Street and distorting market forces. The president-elect and Mr. Mnuchin look forward to working with both parties on reforms that protect taxpayers.”

Trump’s team also wrote Mnuchin’s earlier comments didn’t imply anything other than that Fannie Mae and Freddie Mac shouldn’t remain under government control, a concept that they said had bipartisan support and was mentioned in House Speaker Paul Ryan’s fiscal 2017 budget proposal.

‘Eventual Elimination’

Ryan’s spending plan “envisions the eventual elimination of the mortgage giants by calling for the privatization of their operations and an end to their government guarantee and taxpayer subsidies.”

Nela Richardson, chief economist for real-estate brokerage Redfin, said their would be big risks in taking away government backing for Fannie Mae and Freddie Mac.

The companies are “intrinsically intertwined in the American housing system” and losing government support, as some Republicans have proposed, “has huge implications, including higher interest rates,” Richardson said.

Fannie Mae and Freddie Mac don’t make mortgages. They buy them from lenders, wrap them into securities and make guarantees on principal and interest to investors. With the companies under federal control, the government itself now backs up that guarantee. The process underpins the mortgage market and makes inexpensive 30-year, fixed-rate mortgages widely available in the U.S. while they’re a rarity elsewhere.

Any changes to how the companies operate, no matter what those changes are, could have a large impact on mortgage rates and, by extension, home prices and ownership rates.

Stop Subsidizing

Conservatives in Congress have long argued that the U.S. should stop subsidizing the mortgage market. Democratic lawmakers, meanwhile, have sought to preserve the companies’ mission of promoting broader homeownership.

Representative Jeb Hensarling, the Texas Republican who heads the House Financial Services committee, has sponsored legislation that would wind down Fannie Mae and Freddie Mac in five years. While some people believe such an outcome could take taxpayers off the hook for bailing out the mortgage market in a future crisis, it could also sharply boost interest rates for riskier borrowers, especially in bad economic times.

“Anything that involves a government guarantee is not a good idea,” said Ed Pinto, who heads the International Center on Housing Risk at the conservative American Enterprise Institute. “They have to be allowed to fail.”

Some private shareholders and other advocates say the White House and the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, could use existing authority to rebuild capital in the companies, end their conservatorships and release them back into the market. They say that the firms could be regulated akin to utilities and that taxpayers would be protected by stronger regulations and high capital requirements.

Myriad Proposals

There also are myriad proposals from lawmakers and policy experts, most of which would require legislation. One closely-watched option from former Senate staffer Michael Bright and ex-FHFA chief Ed DeMarco would turn Fannie Mae and Freddie Mac into lender-owned mortgage insurers.

Regardless, Republican lawmakers will probably expect to have significant involvement in deciding what to do with Fannie Mae and Freddie Mac, so if the Trump administration tried to act without congressional participation it could spark an intra-party feud. 

Senators may use Mnuchin’s confirmation hearings as an opportunity to get the Trump administration to commit to working with lawmakers on whatever comes next, said Brandon Barford, a partner at Beacon Policy Advisors in Washington.

“I would fully expect that a senator will ask Mr. Mnuchin for clarification of his remarks on Fannie Mae and Freddie Mac and extract a pledge from the nominee to work with Congress on housing-finance reform and avoid unilateral action on such a historically polarizing issue,” Barford wrote in an e-mail.

Ultimately, the stark political differences on reform and the huge ramifications for the housing market could continue to stifle action.

“I don’t think anything that significantly changes the status quo is particularly good for the housing market,” said Guy Cecala, publisher of trade publication Inside Mortgage Finance. “For better or for worse, we have a housing market that’s overly dependent on government support.”