Last Month: Markets think Mnuchin wants privatization
Earlier last month, Donald Trump’s pick for Treasury Secretary Steven Mnuchin stated that getting Fannie and Freddie out of government control is “on the top 10 list of things that we’re going to get done.” He went further, stating:
“It makes no sense that these are owned by the government and have been controlled by the government for as long as they have.We’ll make sure that when they’re restructured, they’re absolutely safe and they don’t get taken over again. But we gotta get them out of government control.”
Treasury and mortgage markets went into a bit of a tizzy when they heard that, and both Fannie and Freddie’s stocks shot up over 40%.
Now: Mnuchin backtracks
Mnuchin had his confirmation hearing before the U.S. Senate Finance Committee a few days ago, during which he was asked about these statements. In a somewhat surprising turn of events, Mnuchin backtracked a little and stated that it was not his intent to come off in support of “recap and release” (i.e. the recapitalization of Freddie and Fannie and the release of control back to shareholders).
He went on, saying that:
“I start with the standpoint [that] the status quo is not acceptable, of just leaving them [Freddie and Fannie] there. I believe we need housing reform, and we need to make sure that, whatever the outcome is, one, we don’t put the taxpayers at risk and two, we don’t eliminate capital from the housing market.”
Understandably, stock prices for both companies fell about 10% after the news broke. But while Mnuchin may have retreated a bit during his confirmation, he still maintained that change is coming. It’s unsure what exactly that change will look like, especially if Mnuchin is trying to get both sides of the aisle on board.
Still, right now is a good time to take a look at some of the issues around housing reform and how it might affect home buyers.
How the mortgage market works right now
The secondary market
A quick primer: It come as a surprise at first, but mortgage lenders don’t earn a profit from the interest on the mortgages they lend out. Instead, they sell the mortgages out to buyers on the secondary market.
It makes sense when you realize that it can take up to 30 years for some mortgages to be paid off. Businesses need cash in order to operate effectively, and having to wait 30 years for a full return on an investment would stagnate their cash flow and ultimately be unfeasible. After all, they need money right now to be able to loan out money to other clients.
Hence, the secondary mortgage market was born.
There, we have multiple entities all competing for primary market loans, which they then package up into mortgage-backed-securities (MBS) (think a mutual fund filled with mortgages). Packaging multiple (sometimes hundreds) of mortgages into a security decreases the threat of default that would be more prevalent if it were just one mortgage. After all, if your only investment defaults, you’re out of luck, but if one out of five hundred defaults, it’s not that bad.
Fannie and Freddie Mac as GSEs
There are a number of different entities buying mortgages on the secondary market, but by far the two largest purchasers are the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Both of these organizations, since the 2008 financial crisis, have been Government Sponsored Enterprises, or GSEs. As such, they operate under a mandate to purchase loans from mortgage lenders across all economic conditions in order to ensure lenders have enough liquidity.
Currently, with the government’s implied support, securities bought and packaged from Fannie and Freddie have the government’s stamp of approval. They’ve met the underwriting requirements of the FHFA, and investors like that. They feel safe going with Fannie and Freddie.
One way to think about the situation is that the United States government essentially acted as a co-signer for riskier borrowers. That is basically the big difference between Fannie and Freddie and the other entities on the secondary mortgage market. They have no such co-signer, and are therefore unable to purchase some of the riskier mortgages.
Privatization of Fannie and Freddie
Even when everyone thought that Steven Mnuchin wanted to privatize Freddie and Fannie, it wasn’t as if he would have been able to walk into his office on his first day as Treasury Secretary and make it happen with a few simple phone calls.
In fact, thanks to legislation passed in 2015, the federal government cannot end conservatorship without the approval of Congress until after 2017. It also might have been extremely challenging for Mnuchin to get not just Democrats to sign off on a privatization bill, but Republicans who want to completely abolish (not just privatize) the two mortgage giants.
Even after 2017, when there will be more leeway for Mnuchin to affect change, he would still have do deal with several issues in order to make privatization happen.
So what will Mnuchin do?
Mnuchin stated on Thursday that he is not in favor of recap and release, but he did say that Freddie and Fannie cannot be left alone.
The main question that lawmakers will have to answer over the next four years is how much government involvement in the mortgage industry there should be. Mnuchin and the rest of the Trump administration seem to be leaning toward decreasing government’s presence in the secondary market, but there’s no easy way to go about that.
Housing reform is a contentious issue among Republicans and Democrats, making it difficult to find a solution that everyone agrees on. However, the fact that Mnuchin is eager and willing to go after bipartisan reform is hope that some sort of change will take place.
Of course, Mnuchin has yet to be nominated, and took some serious heat on Thursday from Democrats about his days at OneWest Bank. It’s possible that they block his confirmation, and Mnuchin’s housing reform would become a moot point, but that path seems unlikely.
Bottom Line
Treasury secretary nominee Steven Mnuchin seems set on changing the way Fannie and Freddie Mac operate, but it’s unclear how exactly he will seek to change things. It’s important for homeowners to keep an eye out to see if a) he gets confirmed and b) what kind of bipartisan legislation he will try to get passed.
from Total Mortgage Underwritings Blog http://ift.tt/2jJgfRu
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