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Mortgage Rates Would Rise if Fannie and Freddie are Ended

Competing bills in the House of Representatives and the Senate would wind down both Freddie Mac and Fannie Mae, the government sponsored entity (GSE) mortgage guarantee companies. Freddie and Fannie provide a secondary market for home mortgages after these loans are made to consumers. They purchase mortgages from the lenders who originate them, freeing up capital for lenders to make more mortgage loans.

Both Freddie and Fannie had to be bailed out by taxpayers to the tune of $187 billion after the housing bust. The bailout is the main reason politicians want to limit or close both Fannie and Freddie. However, getting rid of the GSEs might be a mistake and you would think politicians would learn from the recent past.

Spread Between Conforming and Jumbo Mortgage Rates Would End

Without the GSEs, the Federal Reserve wouldn't been able to drive mortgage rates as low as they did the past three years. Winding down or severely limiting the GSEs will cause conforming mortgage rates to move higher. Jumbo mortgage rates are .50 percent to 1 percent higher than conforming rates because the GSEs don't buy jumbo loans, which are loans of $417,000 or more. There are higher conforming limits in more expensive housing areas of the country.

If the GSEs are ended, the spread difference between conforming mortgage rates and jumbo mortgage rates would end. This would mean higher carrying costs for homebuyers on a monthly basis. For example, just a 0.50 percent higher rate would mean $31 more a month in interest payments on each $100,000 borrowed.

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GSEs Still Dominate the Secondary Mortgage Market

After the housing bust, the GSEs also played a vital role in recovery by purchasing about 90 percent of all conforming loans made. The GSEs still play a vital role today in the housing market. They continue to purchase a majority of home loans made, which provides much needed liquidity to the market. Lenders are more willing to make loans to homeowners knowing that they could be sold to the GSEs.

Before the housing bust the GSEs weren't as dominant in the secondary market for mortgages. Private investors also bought mortgages that were packaged together in mortgage-backed securities (MBS). After the housing bust, MBS became toxic investments that no one wanted to touch. MBS were the reason why Lehman Brothers failed and Bear Sterns was sold for $1 to JPMorgan Chase.

President Obama Talks Housing and the GSEs

President Obama is also talking about ending Freddie Mac and Fannie Mae in a recent speech. The President said the following:
For too long these companies were allowed to make huge profits buying mortgages, knowing that if their bets went bad, taxpayers would be left holding the bag. It was heads we win, tails you lose, and it was wrong. The good news is right now there's a bipartisan group of senators working to end Fannie and Freddie as we know them. And I support these kinds of reform efforts.

You can watch the Presidents speak about the current housing market and ending Freddie Mac and Fannie Mae below:

The House of Representatives bill, a Republican plan, would privatize the secondary mortgage market. The Senate's bill both Republicans and Democrats support would have the government still pay a role in the market but a more limited role in insuring mortgage securities.

Try Getting a Home Loan When the Next Financial Crisis Hits

I agree something has to be done with the GSEs but totally privatizing the secondary mortgage market would be a mistake. When the next recession and financial crisis hits and investors stop buying MBS, mortgage rates would quickly move higher. Higher mortgage rates would cool demand for loans exacerbating any recession.

In a worse case scenario potential homebuyers would even be able to get a loan regardless of how good their credit is. If things got really bad the government would have to step into secondary market again and buy loans.

Freddie Mac and Fannie Mae Financially Healthy

Since the housing bust more stringent lending requirements were set and both Freddie Mae and Fannie Mae are healthy again. The GSEs are reporting record profits and have already paid back the government tens of billions of dollars.

Fannie Mae has paid $95 billion of its $117 billion debt, and Freddie Mac has paid $30 billion of its $72 billion debt. Overall there is still $65 billion to be paid back to the government so we should at least wait until the debt has been paid before getting rid of Fannie and Freddie.
Author: Brian McKay
August 14th, 2013