Ground Shifts for Fannie, Freddie

Ground Shifts for Fannie, Freddie

Since they were seized by the federal government and bailed out with more than $200 billion in taxpayer funds, government-sponsored entities (GSEs) Fannie Mae and Freddie Mac have been in a kind of limbo.

The Fannie Mae and Freddie Mac programs continue to be the leading source of permanent financing for the apartment business. But they are controlled by the Federal Housing Finance Agency (FHFA), which is committed to shrinking their market presence. Moreover, debate has rung through Congress for years about what to do with the agencies—whether to privatize them, wind them down or continue to run them in their current versions.

It’s impossible to know what Congress will eventually do. But recent developments, including a set of reports from the FHFA, the rising value of the GSEs and the strengthening market for single-family homes point to the potentially high cost of stripping Fannie and Freddie of their government guarantees.

Congress continues to clamor for Fannie and Freddie to be broken into pieces. “There is general—almost unanimous—consensus,” said Congressman Mel Watt (D-N.C.) in an interview with the Wall Street Journal. “We want to transfer as much of this back to the private sector as the private sector can take — and without an explicit or implicit government guarantee.” Watt is President Obama’s pick to run FHFA, but still faces Senate confirmation proceedings.

There are limits to how far Congress can take its urge to take Fannie and Freddie apart. “There are constraints,” Watt continued. “Safeguarding what we are already into is probably the primary challenge.”

Protecting the value of Fannie and Freddie has become more important now that there is once again value to protect. Fannie Mae will return $60 billion in profits to the Treasury Department this spring alone. By 2020 if not sooner, the GSEs will have returned all of the $250 billion in bailout funding they received in the financial crisis, experts say.

“I don’t think we are going to liquidate them if they are making money,” says John McIlwain, senior resident fellow and J. Ronald Terwilliger chair for housing at the Urban Land Institute. Legislators may also be under pressure to not damage the healing market for single-family homes, which is finally helping to grow the U.S. economy. “It’s a very fragile market supported by the federal government,” says McIlwain. “If they change it, it can get worse.”

In March, the FHFA published a strategic plan that called on Fannie and Freddie to enact a 10 percent reduction in the unpaid principal balance amount of their new multifamily businesses. Under the directive, Fannie and Freddie’s combined multifamily lending would be reduced to $56.9 billion in 2013 from $63.3 billion in 2012.

Then on May 3, the FHFA released two reports about Fannie and Freddie that sketch out what might happen if their multifamily lending business were privatized and stripped of their government guarantees, which keep interest rates low for Fannie and Freddie multifamily loans.

The verdict was straightforward: “Without a government guarantee, a fully private company may not provide the same level and scope of services in the marketplace, at least at current prices,” according to the reports.

For example, lending on affordable housing properties or small apartment properties “may not be practical due to the high cost, relatively low profitability and difficulties with securitization.” Also, without a government guarantee, Fannie and Freddie’s multifamily lending would be subject to the volatility of the capital markets. In another financial crisis, they would probably shut down, just like other securitized lenders shut down during the last crisis.

Change could also reduce Fannie and Freddie’s ability to pay U.S. taxpayers for the cost of the bailout.

Without the government guarantee, the Fannie and Freddie’s current multifamily lending businesses have little inherent value, according the reports. The sale of these businesses without the guarantee would return little or no value to the U.S. Treasury and to taxpayers.

Separating the multifamily lending business could make it difficult to raise private investment. “It is not an easy thing to capitalize a monoline business. The capital markets do not look that kindly on that these days,” says David Brickman, senior vice president and head of multifamily for Freddie Mac. “If you narrow the market space too much then you are not going to be able to capitalize the entities.”

Legislators might be skeptical of Fannie and Freddie’s reports, since they come from agencies that face dismemberment. Fannie and Freddie’s report is based on analysis from private companies including Morgan Stanley and Barclay Bank, Moody’s Investors Service and CBRE. “We asked three groups of economists and we got three very similar opinions,” says Freddie Mac’s Brickman.

Specific data from the private companies isn’t available, since the federal conservator in charge of the agencies hasn’t released its reports. To confirm the information in the report, the National Multi Housing Council (NMHC) is reaching out directly to these companies. “We come to many of the same assumptions that Fannie Mae and Freddie Mac have quantified,” says David Cardwell, vice president of capital markets with the NMHC. “We believe what is in the report.”

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