Mortgage Insurance Privatization

Late last week, The White House released its long-awaited plan to reform the nation’s housing finance system and privatize Fannie Mae and Freddie Mac, calling it the "last unfinished business of the financial crisis.” In the report, they call these mortgage insurers who are currently under government conservatorship, government sponsored enterprises or GSE for short. 

In the good old days, Fannie and Freddie operated with different models. Freddie would sell its loans on the open market using mortgage backed securities as the vehicle. Fannie on the other hand kept the loans on its balance sheet. 

The really high interest rates of the early 1980’s pushed Fannie Mae to the brink of insolvency, after which they adopted the same approach as Freddie Mac.

In the middle of the credit crisis of 2007-2008, the Government stepped in and bailed out both Fannie and Freddie in the middle of 2008, although it was apparent by early 2008, that some drastic steps would be required to save the financial system.

I’m quoting from the report issued by the Treasury Department to the White House late last week. “The housing finance system is in serious need of reform. The GSEs remain in conservatorship more than 10 years after the financial crisis, and they continue to be the dominant participants in the housing finance system. Although they remain critical to the functioning of that system, they are not yet subject to capital and other regulatory requirements tailored to the risks they pose to financial stability. This lack of reform has left taxpayers exposed to future bailouts. The lack of reform has also prolonged the Federal Housing Finance Agency’s (“FHFA”) management of the GSEs through the conservatorships, perpetuating far-reaching Government influence over the housing finance system.

The idea is that a conservatorship is temporary and therefore there should be a timetable and a framework for returning these enterprises to the private sector.

Most of the recommendations in the 53-page plan, released to the public on the eve of Friday's 11th anniversary of the government takeover of Fannie Mae and Freddie Mac, don’t require input from Congress.

Predictably, the Democratic Congress members were quick to denounce the plan.

The largest impact of the privatization is likely to be on the underwriting rules which would affect loan eligibility for borrowers. The second would be the cost of the mortgage insurance premium. Today in the multi-family market, that insurance premium varies according to the ratio and the risk factors calculated by the underwriters. It’s possible that under the new regime, once these enterprises are privatized, that insurance premiums increase. However, I personally don’t see these premiums being much higher than the actual government backed guarantees under the HUD and FHA programs. I expect the newly privatized offerings to be price competitive. They are, after all offering the same service.

While I do expect that privatizing these entities will reduce the taxpayer exposure to future bailouts, it won’t eliminate the exposure. Since the offering will need to be price competitive with the government offerings, I don’t anticipate major changes to the cost of these offerings.