Photographer: David Paul Morris/Bloomberg
Fannie-Freddie Talks Set Competition as the Cost of FreedomBy
Senators want to keep U.S. control until competitors emerge
Corker-Warner proposal aims to lower barriers to market entry
If no rivals develop, the mortgage-finance giants could remain where they are now: under government control.
A plan being developed by Republican Bob Corker of Tennessee and Democrat Mark Warner of Virginia would lower barriers to entry by removing some advantages Fannie and Freddie now possess. The goal is to create a system sturdy enough to withstand the failure of any one company and avoid a rehash of the taxpayer rescue that occurred during the 2008 financial crisis.
“If you want to eliminate too-big-to-fail, you need to have enough guarantors that you’d really let one fail in the event of a downturn,” said Mortgage Bankers Association President David Stevens, who served as Federal Housing Commissioner during President Barack Obama’s administration.
Because there’s no guarantee that the changes will be enough to attract competitors, the senators have come up with a fail-safe: Fannie and Freddie will stay within the government’s grip unless new companies enter the business of backing the mortgage market, according to people familiar with the matter.
Corker said in an interview last week that he wants to ensure no one company has too much market dominance. Warner, in a statement last week, said the lawmakers are pursuing a “simplified approach that protects the taxpayer, preserves the 30-year fixed mortgage, and includes robust access and affordability provisions.”
Fannie and Freddie don’t make mortgages themselves. They buy them from lenders, wrap them into securities and make guarantees to investors in case loans default. The U.S. government took over the companies during the 2008 credit crisis, and eventually injected them with $187.5 billion in bailout money. They have since become profitable and paid more than that in dividends to the government.
In developing their proposal, Corker and Warner are confronting a quandary that’s befuddled every policy maker who’s dreamed of a system to replace the current duopoly. Fannie and Freddie have decades of experience and infrastructure in buying, securitizing and guaranteeing home loans, so any new competitors would face significant disadvantages.
In the current version of the senators’ plan, competitors to Fannie and Freddie would have access to the platform the two companies are developing for securitizing mortgages. And mortgage-backed securities would be supported by guarantees sold through Ginnie Mae, a government-owned corporation whose purpose is to make mortgages more affordable.
Corker and Warner earlier considered breaking Fannie and Freddie into smaller companies, but they received negative feedback from lenders and other housing-finance experts who expressed worry over the logistics of such a move, according to people who spoke to them or their staffs.
While some proposals have advocated for Fannie, Freddie and competitors to have regulated rates of return, such as utilities, the lawmakers’ plan doesn’t have that feature, according to people familiar with the matter. Instead, the hope is that having multiple companies will keep pricing competitive. The plan would make some regulations tougher for large guarantors in the hope that doing so would encourage smaller companies to enter the fray.
The senators’ staff members and others in the housing-finance community have reached out to companies and investors over the past several months to see what features would be needed to entice competitors. Among those interested in trying: private mortgage insurers, whose businesses are currently limited to protecting Fannie and Freddie from losses on low-down-payment mortgages.
Insurer Arch Capital Group is among the firms that have expressed interest, according to multiple people who spoke with executives there. An Arch spokesman declined to comment.
Many other private mortgage insurers are likely to be interested as well, according to Chris Gamaitoni, assistant director of research at Compass Point Research & Trading. “While our policy view is that it is unlikely this bill will pass this Congress, we believe the potential is a ‘moon shot’" for mortgage insurers, he wrote in a research note on Friday.
Increased competition could meet resistance from small lenders, who might chafe at the idea of having to adapt to the underwriting systems of many more secondary-market players, said Glen Corso, executive director of the Community Mortgage Lenders of America. He also said he fears that large banks could find a way to control a new competitor, creating an advantage for themselves.
Fannie and Freddie “are essentially gateways to the capital market for midsize and small lenders,” Corso said. “How many gateways do you really need?”
The Corker-Warner plan would attempt to allay that fear by limiting mortgage lenders, including banks, from having more than a minimal stake in any guarantor, according to people familiar with the matter. It would also mandate equal pricing and access to the system for all lenders.
Some housing-finance experts disagree on the need for competition. Having rivals to Fannie and Freddie could even be counterproductive, said Andrew Davidson, president of a New York-based consulting firm that bears his name.
One issue, Davidson said, is that mortgage financiers often don’t face losses from bad decisions until a downturn, which can occur years after a loan is made. That could lead to a “race to the bottom,” as firms attempt to outdo each other for business, and if a severe downturn struck, many companies would come under pressure at once, potentially leading to bailouts anyway, he said.
“It’s just as unstable, because it’s easy to gain market share through mispricing or taking on excess risks,” Davidson said.