The Case Against GSE Privatization

Blog posted On January 17, 2017

Among the list of impending policy changes under the new administration, there has been ample talk about the privatization of Freddie Mac and Fannie Mae.  The lenders became government sponsored entities in the wake of the financial crisis, accepting a $188 Billion bailout.  Since they were placed under conservator-ship, the GSEs have repaid their bailout and more to the US Treasury.  With the housing market rising to pre-recession strength and mortgage rates hovering historical lows the question arises, is it time to take Freddie Mac and Fannie Mae out of government conservator-ship? 

The Kroll Bond Rating Agency sent out a research note examining some of the potential challenges of taking Freddie Mac and Fannie Mae out of government conservator-ship.  In the note, KBRA stated:

“The GSEs provide a substantial subsidy to the housing finance market first by using the superior credit standing of the U.S. government to support the sale of securities secured by 1-4 family home loans. […]  The GSEs also act as guarantor for these mortgage securities, taking the first-loss credit risk on the underlying loans. By guaranteeing the credit risk, the GSEs make it easier for the bond market to deal with the long and variable duration risk of a 30-year mortgage.  Finally, the implicit governmental guarantee for the securities issued by the GSEs makes possible a forward, “to be announced” (TBA), market that allows for the efficient management of interest rate risk. Mortgage lenders are able to hedge their interest rate risk against a homogenous and fungible agency security in the future, usually 30-60 days forward.”

The KBRA asserts that privatization can cause more problems than it solves.  The cost of taking Freddie Mac and Fannie Mae out of government conservator-ship could be passed on to the consumer, paying higher interest rates.  KBRA Senior Managing Director, Christopher Whalen, predicted, “If you were to [privatize Freddie Mac and Fannie Mae], the cost of a mortgage for your average consumer would go up several points — it would be more like 6 or 7 percent — because private investors are just not willing to take the risk.”

Sources: HousingWire, MarketPlace