Today Fannie Mae and Freddie Mac control the secondary market. But increasingly regulators are talking about adding competition. What would that look like? How would it happen? And could they compete with today’s mortgage giants?
Many plans for reforming the government-sponsored enterprises include creating multi-guarantor systems that would provide more competition within the marketplace and eliminate the risk of too big to fail. Given the years of experience behind the GSEs, certain factors would have to be put in place first in order for new entrants to be able to compete with Fannie Mae and Freddie Mac.
Regulators would also need to assess the market interest to determine if there are potential competitors waiting to rise up, should market conditions provide the opportunity. But first, the GSEs must be removed from conservatorship.
This history behind conservatorship
Nearly 15 years ago, two of the biggest mortgage giants in our space, The Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, were losing market share. Fannie Mae and Freddie Mac’s share of new mortgages issued fell from about 70% in 2003 to just 40% in 2006. That’s because competition continued to increase from lenders who would generate loans to just about anyone. Remember NINJA loans – no income, no job and no assets?
Buyers were given low-rate options from lenders looking to generate a quick profit despite that rate being set to skyrocket in five years, leaving them unable to afford their payments.
It was the Wild West, anything goes, and non-QM and subprime mortgage lenders increased in market share.
2008 changed everything. After the housing crisis, the Federal Housing Finance Agency took Fannie Mae and Freddie Mac into conservatorship.
With the consent of both Fannie Mae’s and Freddie Mac’s board of directors, FHFA used its authorities to place each enterprise into conservatorship. FHFA established two conservatorships in response to a substantial deterioration in the housing market that severely damaged each enterprise’s financial condition and left both of them unable to fulfill their missions without government intervention.
“Over the last three years the Office of Federal Housing Enterprise Oversight, and now FHFA, have worked hard to encourage the enterprises to rectify their accounting, systems, controls and risk management issues,” then FHFA Director James Lockhart said at a news conference in 2008 that announced the beginning of conservatorship. “They have made good progress in many areas, but market conditions have overwhelmed that progress.”
“The result has been that they have been unable to provide needed stability to the market,” Lockhart said. “They also find themselves unable to meet their affordable housing mission. Rather than letting these conditions fester and worsen and put our markets in jeopardy, FHFA, after painstaking review, has decided to take action now.”
Once conservatorship began, subprime diminished, and non-QM became only a small piece of the mortgage market.
Since then, Freddie Mac has repaid a total of $119.7 billion to the U.S. Department of the Treasury, exceeding its original draw during the financial crisis by about $48.1 billion. Fannie Mae has repaid a total of $181.4 billion, compared to $119.8 billion that it drew.
During this conservatorship period, regulations have tightened, the government passed the Dodd–Frank Wall Street Reform and Consumer Protection Act, the Consumer Financial Protection Bureau zeroed in on anyone close to subprime, and a new era was born. During this time, Fannie Mae and Freddie Mac have continued to increase their market share, strengthening their hold on the mortgage industry.
As of mid-2018, the private-label securitization market came in slightly under $500 billion and was split among prime at 18.8%, Alt-A at 37% and subprime at 44.3% loans. This is compared to outstanding securities in the agency market at that time, which totaled $6.47 trillion and were 43.6% Fannie Mae, 27.4% Freddie Mac and 29.1% Ginnie Mae, according to data from the Urban Institute. Before the crash, the private-label securities market stood at more than $2 trillion.
The end of conservatorship
After more than a decade, the market is shifting again, and despite a lot of talk over the past few years that failed to amount to much of anything, an end to conservatorship is in sight.
In September 2019, President Donald Trump and his administration released the long-awaited plan to reform the nation’s housing finance system. The 53-page plan called it the “last unfinished business of the financial crisis,” and detailed what this would look like in execution.
By the end of that same month, the Treasury and the FHFA officially announced that the GSEs can retain up to $45 billion in combined capital as they prepare to leave conservatorship.
“FHFA commits to working with Treasury in the coming months to amend the share agreements and further advance broader housing finance reform,” FHFA Director Mark Calabria said at the time. “The reform goals include limiting the government’s role in housing finance, increasing marketplace competition, focusing on affordable housing and sustainable homeownership. The status quo is not an option. Now is the time to act.”
As the end of conservatorship moves closer, it spurs a lot of questions about what the market will look like in a post-conservatorship world. One question that keeps coming up is the possibility of new entrants to the market that would compete with Fannie Mae and Freddie Mac.
Calabria even urged Congress to take steps to increase competition for Fannie Mae and Freddie Mac, stating in his GSE reform wish list for lawmakers that more competitors in the space “would reduce market reliance on either enterprise and enhance market stability, as well as benefit homebuyers.”
Fannie and Freddie are both government-sponsored enterprises. A GSE is a quasi-governmental entity established to enhance the flow of credit to specific sectors of the American economy. Created by acts of Congress, these agencies, though privately held, provide public financial services. GSEs help facilitate borrowing for all sorts of individuals, from students to farmers to homeowners.
When HousingWire spoke with him in January, David Stevens, former Mortgage Bankers Association President and CEO and former commissioner of the Federal Housing Administration, said that some are concerned that an end to conservatorship will only free the mortgage giants to once again start down a path that will lead to the need for yet another government bailout, and that would put taxpayers at risk. A more level playing field and the addition of more “GSEs” would reduce that risk.
In fact, even Fannie Mae and Freddie Mac themselves agree that more competition is better for the market.
At the annual MBA conference last year, Fannie Mae CEO Hugh Frater and Freddie Mac CEO David Brickman declared they were ready for any competition that might arise.
“Bring it on,” Frater said. “We welcome the competition; it uniformly makes things better.”
However, the CEOs were very clear that any new players would have to operate under the same rules that Fannie Mae and Freddie Mac operate under. This means serving every market everywhere. They explained that Fannie Mae and Freddie Mac have had years to perfect their game, leaving the future competition to do a lot of catching up.
The rise of Fannie Mae and Freddie Mac competitors
The addition of new GSEs will take more than just a wish list from Calabria. It’s going to need some legislation.
While the FHFA doesn’t currently have the authority to create new GSEs, the Treasury’s plan to end conservatorship lays out a path for more competition within the market. The plan gives the FHFA the authority to grant charters to new companies that want to become government-sponsored enterprises.
As it stands now, the government guarantee backs the entire company, no matter what it does. However, changes suggested in the Treasury plan and from several plans in the industry such as the plan the MBA submitted, suggest not giving companies an explicit guarantee, but rather just guaranteeing the mortgage backed securities themselves.
“The theme is right now that with government guarantees behind Fannie Mae and Freddie Mac, even if you move it to just behind the mortgage-backed securities, there’s still only two of them. In the event of a massive collapse, like the recession we just saw, they’re both likely too big to fail,” said Stevens. “The theory is you get more competitors in, and if one fails, there are others to pick up the slack. You eliminate the too big to fail risk, and it creates more competition.”
“And all of that ultimately is safer and better for taxpayers and probably lenders,” Stevens continued.
Under a plan that would allow for more competition in the marketplace, potential new guarantors would have to take the first step toward receiving approval to become a GSE – raising capital. They would need what accountants call, “capital to establish yourself as a going concern,” Stevens explained.
Today, most new mortgage insurance companies are required to raise at least $500 million in order to receive their charter. Potential regulations to become a GSE might look similar to this, Stevens explained.
Even though Frater and Brickman welcome new competition, new entrants to the market would have one advantage over the existing mortgage giants: They would not need to raise as much capital. Since they wouldn’t already hold trillions of dollars in loans in their portfolio, they would have much less capital to raise.
Even if new regulations mandated they raise $1 billion or more, it wouldn’t come near the expected $200 billion that the existing mortgage giants are expected to need before they can leave conservatorship, Stevens said.
In order to allow new entrants to compete, the requirements would need to change slightly. First, they would need the same pricing, and the ability to roll through the same uniform mortgage backed security platform as Fannie Mae and Freddie Mac.
On the lending side, new entrants would need to compete for originations. Currently, Freddie Mac has its Loan Prospects system and Fannie Mae has Desktop Underwriter, their own proprietary systems that are subject to regulation. The new plan would need to call for an underwriting model controlled by the regulator. If this happened companies such as CoreLogic, Black Knight or Ellie Mae could create an underwriting system that new entrants could use, rather than starting from scratch.
In fact, some have even proposed that all data creating underwriting systems should be open architecture that any new guarantor would have access to, Stevens explained.
If that happened, Fannie and Freddie would no longer have hidden data controlling black box underwriting models, Stevens explained. The advantage of their size and scope would nearly be eliminated.
If legislators create a new model with data openly available as it releases the GSEs from conservatorship, as well as allow multiple guarantors access to the UMBS and the common security, the system would be close to total parity, Stevens said.
“Nobody really has an advantage other than how good they are at technology, how good their sales team is, how quickly they respond to problems and that kind of thing that will ultimately be the factor in who mortgage originators will sell their loans to,” he continued.
If you build it, they will come
Theoretically, with the right regulations in place, companies could rise to compete with Fannie Mae and Freddie Mac, increasing competition and potentially eliminating the too big to fail concern hovering over the secondary market.
This is a theory that Congress decided to put to the test back in 2014. Sen. Mike Crapo, D-Id., and Sen. Tim Johnson, D-S.D., released a housing finance reform plan that would create a multi guarantor model. In the plan, they questioned if there would be any companies that are interested in becoming a guarantor if they created legislation to open that door.
According to HousingWire sources, as legislators began reaching out to companies to see if there was interest, they were met with a resounding yes, with the most likely entrants being mortgage insurers and investment bankers outside of the mortgage space that have access to capital.
“My own perspective, as someone who spent my career in this industry, is we’d be far better off with more competitors,” Stevens said. “It can be done, and I do believe there are new entrants that would come in. But you’ve got to lower the barriers to entry.”
The ball is now in Washington’s court.
