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Reforming Fannie and Freddy: Is It Bad for the Multifamily Market?

Given the accounting scandals at both Fannie Mae and Freddie Mac, it’s no great shock that the two companies are bracing for increased regulatory oversight. In fact, both government-sponsored entities (GSEs) have asked for it and a bill has been introduced in Congress to create a new independent regulator with far-ranging powers to monitor the companies that guarantee mortgage-backed securities (MBS) of roughly $3 trillion combined. The companies also hold a combined $1.5 trillion in residential mortgages, managing these portfolios through the use of “swaps” (derivatives used to hedge or alter interest rate exposure).

The question for players in the multi-family real estate industry (investors, developers and lenders) is whether the reforms will cramp their style. The National Multi Housing Council (NMHC), the trade association for apartment building owners, is sounding the alarm—saying that well-intentioned efforts could put a damper on multifamily lending. Conversely, the Mortgage Bankers Association (MBA) is concerned that the two companies are encroaching on the primary lending market. As a result, the MBA is lobbying for stronger regulation of both Fannie Mae and Freddie Mac.

Underlying this mixed bag of concerns is the critical role that Fannie Mae and Freddie Mac play in maintaining the liquidity of the secondary mortgage market. Fannie Mae and Freddie Mac officials recently testified on Capitol Hill that they welcome introducing a stronger regulator. However, the representatives said that both companies are opposed to a key feature of the proposed legislation—placing limits on the sizes of their portfolios. It’s far from clear how much of the portfolio value will be thinned. For years, Federal Reserve Chairman Alan Greenspan has warned that both GSEs should limit their mortgage portfolios over the danger to the economy that’s posed by the failure of one or both companies.

The push to reform Fannie Mae and Freddie Mac has gained momentum over the past few months, with Republican leaders determined to rein in both firms. The proposed reforms are the culmination of financial scandals dating back to 2003, when Freddie Mac dismissed three top executives after disclosing it had overstated earnings by $5 billion. Then, in 2004, Fannie Mae restated $11 billion in earnings dating back to 2001. Accounting errors were cited for the restatement, and the CEO and CFO were subsequently dismissed.

But despite the alarming gaffes, the NMHC is not too thrilled about heavy regulation, because it says the companies’ important services help maintain efficient markets. “Borrowers are concerned that the new regulator will go beyond general safety issues and stifle the innovative work that the GSEs have done in the past,” says David Cardwell, vice president of capital markets and technology at NMHC.

Over the past three years, says Cardwell, Fannie Mae has introduced nearly 30 product improvements that have either simplified or improved the multifamily borrowing process. Last year, for example, Fannie Mae also introduced the Extended Rate Lock (ERL) as a way to insulate borrowers from interest rate volatility. The ERL allows the borrower to lock rates up to 12 months in advance of loan closing, which Cardwell says helps borrowers who anticipate the need to refinance an existing loan.

These innovative measures have greatly benefited multifamily borrowers and helped bring added liquidity to the market, says Cardwell. “Multifamily borrowers rely heavily on Fannie Mae and Freddie Mac, so they are watching this closely,” he adds.

The two mortgage companies have a huge role in the apartment market. Between them, they hold roughly 25% of the nation’s $600 billion in multifamily debt and originate roughly 50% of all multifamily mortgages, according to the NMHC.

Charter Compliance Needed Doug Duncan, chief economist at the MBA, questions whether the innovation concern is entirely justified. His concerns are more focused on defining the boundary between the primary and secondary mortgage markets, which in the MBA’s opinion has been blurred. His association’s members are primary lenders, who don’t like the competition from the companies that have an implied government backup and lower cost of capital.

“Both Fannie and Freddie are active in the primary markets through their customer sales forces,” says Duncan. “We’ve been concerned about that for a while.”

The primary mortgage market consists of retail consumers working with lenders and brokers. If approved, the lender makes the loan to the owner, funds it and ultimately closes the loan. After that, the action shifts to the secondary market where mortgage lenders remarket the loans to other investors, including to Fannie and Freddie.

According to the MBA, Fannie Mae and Freddie Mac have improperly encroached on the primary market. Duncan notes that the Department of Housing and Urban Development (HUD) recently forced Fannie Mae to cease its real estate owned management and disposition activities, which the agency said is beyond the GSEs charter. Congress expressly prohibits both Fannie Mae and Freddie Mac from originating mortgage loans. HUD is responsible for making sure that the GSEs stick to the secondary market.

“We’ve been a strong advocate of reform for Fannie and Freddie,” adds Duncan. “Lately everyone is speculating on how much power the new regulator will have. But if the Senate gets into a real fight over this, all bets are off that a new regulator will even be created.”

Stay tuned. House Financial Services Committee Chairman Michael Oxley (R-Ohio) expects his committee to have the bill ready by next Wednesday, May 25. Meanwhile, another proposed bill sponsored by Rep. Richard Baker (R-La.) would effectively abolish the Office of Federal Housing Enterprise Oversight, the HUD agency that currently oversees all GSEs.

Over the past three years, Fannie Mae has invested $79.2 billion in multifamily housing.*

2004 2003 2002
$21.2 billion $36 billion $22 billion

*Includes debt financing through lender partners and investments with syndication partners.
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