The 'big, beautiful' bang? Or, Fannie Mae be not
Privatisation of the US Government Sponsored Enterprises, an 'on-again, off-again' political topic surrounding the mortgage guarantee providers, is now 'on again'.
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The Federal National Mortgage Association (FNMA, or Fannie Mae) was established in 1928 with the mandate of creating a liquid secondary market for residential mortgage loans. FNMA was privatised in 1968. The Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac) was created in 1970, and given the same mandate as FNMA.
These two enterprises are critical to the efficient functioning of the US mortgage finance market and for the multi-family finance markets, providing guarantees on most mortgage loans and on commercial mortgage loans secured by multi-family properties (apartments). The mission of these enterprises is to facilitate access to affordable housing.
A little history
In 2007, the US housing finance market began to collapse, causing a financial crisis. Fannie Mae and Freddie Mac were, in 2007, private companies. They each had a large, leveraged balance sheet. They each held a large balance of guaranteed agency mortgage-backed securities, and they also had large portfolios of non-guaranteed, or “non-agency” mortgage-backed securities.
As private companies, Fannie Mae and Freddie Mac looked like two of the largest hedge funds in the world.
With their credit guarantee obligations and their large mortgage securities portfolios declining in value, the GSEs struggled. In July 2008, a regulator was created for the GSEs called The Federal Housing Finance Agency (FHFA). The FHFA had the power to advance funds to the GSEs. In September 2008 the FHFA put the GSEs into conservatorship. The US Government purchased $189.5 billion in preferred equity and extended each company a $100 billion line of credit. The US Government took warrants to buy 79.9% ownership in both FNMA and FHLMC, and took control of the board and management.
Currently, under conservatorship, the US Treasury Secretary, Scott Bessent, and FHFA Director, Bill Pulte, are key players in the privatisation efforts for the Trump administration. Both Bessent and Pulte have made clear that the most important metric in any privatisation scheme is that mortgage rates must not increase. A higher cost for mortgages would mean weakened affordability – it would dramatically reduce homeownership and/or housing affordability.
A big change
Today, 99% of all new mortgages in the US are guaranteed by a government sponsored entity or agency: 41% are explicitly guaranteed by the Government National Mortgage Association (GNMA), and 58% are guaranteed by FNMA or FHLMC. Prior to the financial crisis in 2008, the percentage of mortgage loans that were guaranteed was less than 50%. The GSEs were key to stabilising the mortgage finance markets following the housing correction. Since the stabilisation and the conservatorship, there has been no de-stabilisation of the housing markets.
With over $1 trillion of agency CMBS debt outstanding, GSEs make up nearly half of the multi-family/apartment debt share. The presence of Fannie and Freddie in the multi-family market provides a reliable, non-cyclical take-out refinance option. Within the broader commercial real estate market, this unique characteristic has resulted in lower defaults versus other property types.
Multi-family mortgage debt outstanding
Lender | Debt outstanding | Market share |
|---|---|---|
Agency and GSE portfolios and MBS | $1.1 trillion | 49% |
Commercial banks | $629 billion | 29% |
Life insurance companies | $255 billion | 12% |
State and local governments | $92 billion | 4% |
CMBS, CDO, ABS issues | $68 billion | 3% |
Source: Mortgage Bankers Association, December 2024
The GSEs play a notable role in ensuring there is affordable multi-family housing. The FHFA and FHA set targets for the percentage of affordable units the GSEs finance. The FHFA also requires that at least 50% of the GSE’s multi-family lending be “mission-driven": this means prioritising low- and moderate-income households, rural areas, and other underserved communities.
Big bucks?
Many in the Republican Party believe that the government should not be in the business of guaranteeing mortgages. They believe that traditional markets should be the primary provider of mortgage finance; there should be competition. They believe that as the conservatorship was meant to be temporary, it should now cease, given it has already lasted nearly two decades. Their view may be adjacent to a belief that the government should be recouping all or most of the $355 billion investment that the Treasury holds in the GSEs.
A big ask
For privatisation, the three big issues are:
The status of the government guarantee
The capital needed for privatisation
The ongoing role of the US Treasury
The PSPA (Preferred Stock Purchase Agreement) extends a line of credit to support the GSEs. With the PSPA, Agency MBS are understood to have a full guarantee from the US Government. While the guarantee for Freddie Mac and Fannie Mae pools/securities is implicit, it is considered by most to be like the guarantee of US Treasuries, or GNMA MBS, as government debt.
Based on the comments from Bessent and Pulte, we can assume some guaranteed structure is necessary to confirm the continuation of affordable mortgages. A full guarantee seems unlikely to happen, and it would have to be approved by Congress. Politically that seems challenging.
A big problem
Banks receive favourable capital treatment for guaranteed MBS, and some foreign buyers can only buy guaranteed debt. The privatisation of the guarantors would bring uncertainties. Critically, would the new entities be able to provide a full (explicit) guarantee, an implicit guarantee, or no guarantee at all (fully private)?
If the GSE’s were privatised without confirmed guarantee capability, it could lead to a breakdown in the financing structure of the US mortgage market.
The Agency MBS market is over $9 trillion. Privatisation without a guarantee may severely impact access to credit for new mortgages if the guaranteed structure for prior years issuance is not protected or grandfathered, and this could be a large problem.
Privatised GSEs would likely not carry a rating as high as the US government (AA+). If there was no grandfathering of a guarantee; money managers, banks, and foreign buyers may be forced to sell bonds, due to ratings, or even due to exposure limits.
There would be higher capital charges for banks holding fully privatised, lower-rated Fannie Mae and Freddie Mac investments. Banks own $3 trillion, or 33% of all agency MBS, and the Fed owns 25%, or $2.3 trillion. Less capital efficiency would likely result in sales/less demand.
Without categorisation as government debt, the GSEs would be the same as any private company. Questions remain as to if each pool of mortgages remains considered a different exposure. Money managers own 21% or $1.87 trillion in Agency MBS. Foreign buyers own 18% or $1.6 trillion of agency MBS and they largely hold them as US Treasury substitutes because they are viewed as government guaranteed securities. If that guarantee expires, we expect them to sell.
The Fed is one of the largest holders of Agency MBS. They would have to sell because they are only allowed to buy or sell any securities that are direct obligations of or fully guaranteed by any Agency of the United States. Under conservatorship, the Fed could make the case that they are guaranteed, but if the GSEs are privatised, then the bonds may no longer be considered direct US government obligations.
Clearly it is critical to address the guarantee on previously issued Agency MBS/pools, or there may be a massive opportunity driven by forced selling.
A little light
One option to privatise the GSEs, while maintaining the guaranteed nature of Agency MBS, is to maintain the supporting lines of credit that are currently available under the PSPA. This could be done by the FHFA and the US Treasury, without action from Congress. A move to address this in a bill or legislative action would be a clear sign of this path.
Privatising the GSEs would require raising a significant amount of capital. US Treasury interest in GSEs, the “Treasury’s Liquidation Preference”, totals $355 billion. Of the $355 billion, $220 billion is for FNMA and $135 billion is for FHLMC. This amount includes $193 billion of preferred stock: $121 billion for FNMA and $73 billion for FHLMC. Privatisation requires the US Treasury to convert their senior preferred stock to equity. They would also have to waive their warrants.
Since 2019, the GSEs have retained earnings rather than pay a dividend to the US Treasury, and they have now accumulated $161 billion in capital to support future credit losses. While the capital buffer has grown, these earnings occurred during US ownership and only add to the return of capital requirements due to the US government.
The optics are interesting – the GSEs received $191 billion in capital from the US Treasury and they have paid $300 billion in dividends. Some may argue that the government has therefore already been paid back. What matters, however, are contracts. Waiving the additional $161 billion in repayment requires approval of congress, which is sure to face challenge. While a waiver may be challenging, we think the prospects for an IPO are dim without this relief and so a waiver attempt is quite likely.
The big conflict
The US Treasury would own roughly 90% of the company, this would be hard to replace, given the largest IPO ever was Saudi Aramco at $25.6 billion, and that is quite a bit smaller than the envisioned GSE privatisation. Given the size of the “ownership” of the GSEs, we think government interest in the company would need to be reduced over years. The orderly version of the process would take a long time and remains contingent upon the guarantee. With government ownership and the requirement for a government guarantee or PSPA type framework, there would need to be heavy regulation.
There are a lot of questions surrounding how profitable the privatised GSEs will be, and what the regulatory impact might be in terms of policy implementation. Both these issues imply change and likely unintended cost or higher costs if the new entities must raise “guarantee” fees to be profitable. These costs will raise mortgage rates and create friction in a large and structurally important sector (this is a “no-go” according to Bessent and Pulte).
We would expect that a privatised version of the GSEs would require more risk transfer (reduction of exposure to mortgage credit risk). Depending on the ultimate solution it could mean a sale of substantially all the credit risk. Yet, since 2008, the market for prime MBS has been <$60 billion in total outstanding debt. Selling roughly 5%-10% of a $9 trillion market would create a large private credit opportunity and significantly increase the cost of mortgage finance, as yields required increase with developing a new buyer base.
Big, beautiful market
The “to be announced” or TBA market is vital for the structure of US mortgage markets. Home mortgage originators rely on the TBA market to hedge their forward pipeline. The FHFA did a tremendous amount of work to create the UMBS (Universal MBS) TBA market, creating an equivalency between pools of Fannie Mae and Freddie Mac mortgages. UMBS creation increased overall Agency MBS liquidity. If the two GSEs are separately privatised, it may create a bifurcated TBA market again. Issues surrounding the TBA market must be resolved before any privatisation can take place.
The TBA market is large and has an average daily trading volume of $290 billion; only the US Treasury market trades more frequently than TBA Agency MBS. Disruption in the TBA market will disrupt mortgage oriented financial markets.
Another 'big, beautiful' bill?
The Treasury department, together with the Commerce department, were expected to submit a report in May. Currently, there is no word as to the actual timing of this report’s delivery. The report was to assess the feasibility of contributing the GSEs into a sovereign wealth fund (SWF). With a GSE SWF the issues regarding required capital and the government guarantee remain the same as previously discussed in this article.
The big reveal offers little clarity
Agency guarantee MBS is a large market that is structurally important. Any path forward requires a guaranteeing mechanism be confirmed.
Fannie Mae and Freddie Mac would be very large companies. The capital may be hard to come by and there may be substantial governance concerns given ties to government ownership and regulation. The ability to guarantee may come contingent upon policy implementation or control.
The GSEs also provide most of the funding for longer-term multi-family (apartment) financing in the US. This must continue or be addressed as key to affordable living.
How many? Will the private version be one or two companies? Why two?
What is the timeline?
In our view, if the GSE privatisation was rushed, there would be a material dislocation creating a major opportunity to fill the need for capital in an over $9 trillion segment as sellers exit. This could be a large magnitude dislocation that affects all financial markets. Assuming the grandfathering is managed on a new issue basis, there is an opportunity with large scale to provide capital where mortgage credit risk requires financing and/or distribution. GSE credit risk transfer, often called STACR or CAS for the security ticker, may be adversely affected as supply could increase tenfold.
A thoughtful review of the GSEs uncovers many challenges to privatisation. Tackling each of these challenges in an orderly way will require careful analysis from regulators and policy stakeholders. Finding this consensus is sure to take time. For these reasons we see privatisation moving forward slowly, in a multi-year process, rather than the “big, beautiful bang” that some expect.
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