Reshaping The Housing Industry: Why

RESHAPING THE HOUSING INDUSTRY:

WHY FANNIE MAE AND FREDDIE MAC NEED TO BE A SINGLE UTILITY.

Fannie Mae and Freddie Mac have been under the conservatorship of the FHFA for 12 years now. Being under conservatorship means that all the major aspects of the agencies’ operations, processes, and pricing are scrutinized and approved by the FHFA, making the market a de facto regulated duopoly. However, experts feel that time has come to reshape the housing industry through reshaping the housing finance system for the long term. The best way to do this is by releasing the GSEs from their captivity and promoting their evolution by combining both of them into one housing finance market utility.

For years now, much of the debate over the final disposition of the GSEs focused on the systemic risk the entities posed to taxpayers. On the other hand, other proposals suggested establishing a more competitive market with more than just two credit guarantors. However, the main obstacle for a market with more than one credit guarantor is that they tend to amplify rather than reduce systemic risk. This is because the mortgage banking industry is volatile while the firms are entirely dependent on the mortgage business’s performance. The two attributes promote steep competition that worsens in case of a financial crisis.

The two entities should compete on price, product, or service. But due to the FHFA limits and credit policy, GSE-eligible mortgages are homogeneous,

leaving little room for product differentiation.

During the mortgage boom, large originators cut into GSE market share as they were marketing their own versions of Alt-A and subprime mortgage securities under their own label. This led to high risk-layered GSE products such as expanded approval loans. Further, large originators imposed a lot of pressure on the GSEs to reduce guarantee fees in return for market share that undercut pricing for credit in that period.

ARE THE TWO ENTITIES IDENTICAL?

The two entities feature a lot of similarities in many aspects. On the service aspect, the two GSEs compete to deliver highly automated underwriting and collateral valuation services. These tools would come to dominate the secondary market largely by improving the mortgage process’s efficiency while managing risks. Meanwhile, these tools, combined with GSE mortgages partially shaped by the Qualified Mortgage rule, have become massively commoditized. This leaves any real competition by the GSEs attached to the edges of product or service. Therefore, that leaves price rates or the guarantee fees and adverse market delivery fees charged by the entities as the competitive factor. However, these competitive factors have also been effectively eliminated by the FHFA’s strict management.

On the other hand, another distinguishing factor between the GSEs that was removed by the FHFA was the benefits the entities had on the secondary market from the implementation of the Common Security Platform. The entities no longer issue distinctive versions of MBS as was the case before; instead, each entity issue universal mortgage-backed security.

Moreover, the two GSEs feature three virtually identical business lines for single-family, multifamily, and capital markets, and their credit risk transfer initiatives are also identical. This brings us to the question; is there a need for two carbon copies of these entities?

WHAT WOULD IT LOOK LIKE TO RELEASE AND MERGE THE ENTITIES?

It’s evident that the conservatorship period has maintained market discipline, managed risk, and provided the required stability and liquidity to mortgage markets while maintaining profitability for each entity. What would it look like to release the GSEs?

Recapitalizing and releasing the entities could be a viable option but under specific strict conditions that require a strong, capable, and vigilant regulator. However, in the end, this scenario would pose greater systemic risk compared to a regulated monopoly as competition with less regulatory intervention would eventually result in extra-normal risktaking under the right market conditions.

Some would argue that a monopoly is fundamentally inefficient, discourage innovation, and could put mortgage originators on the receiving end. However, some would counterargue that innovation is not as critical with GSE mortgages’ commoditization as it would be in other industries such as technology. Also, the GSEs in their current state are not the exact perfect examples of efficiency.

Combining the two entities into a single housing finance market utility would achieve the objectives sought after for a long since the establishment of both firms. The FHFA has also proven its ability to modulate GSE pricing to adhere to changes in the credit profile of GSE mortgages and has the potential to continue doing so even with the recapitalizing, releasing from conservatorship, and merging of the entities into one private firm the entities have offered an enormous service over the year as stabilizing forces that made homeownership affordable to all in America. The next level in their evolution process is within reach, and the time has come for that to be done.

Work cited.

https://www.housingwire.com/articles/making-fannie-maeand-freddie-mac-into-a-single-utility/.