Will the US privatize Fannie and Freddie since they’re currently needed to boost US credit ratings?

Housingwire was the first to jump on the implications of this story.  Standard & Poor’s upgraded the credit of the US federal government, which is pretty amazing considering it’s in debt for almost $17 trillion and growing very rapidly.  One of the criteria for the upgrade was the better than foretasted financial condition of Freddie Mac and Fannie Mae, which is interesting because they are technically not part of the government, but rather just assets owned by the government.  Obviously, the potential revenue (at least for the time being) is going to influence the decision on the privatization of the Government Sponsored Enterprises.

Fannie and Freddie help brighten America’s credit outlook

By Jacob Gaffney June 10, 2013 • 8:47am

Nearly two years ago, Standard & Poor’s downgraded the U.S. credit rating from triple-A late Friday to double-A-plus — with a negative outlook.

Thanks in part to strong profits from Fannie Mae and Freddie Mac, S&P reports the outlook on the long-term rating is revised to stable from negative.

This development — proof of a stronger housing economy — combined with tax hikes and expenditure cuts are the primary drivers for the S&P decision.

“We believe the U.S. economic performance will match or exceed its peers’ in the coming years,” said a release from S&P.

The credit ratings agency said it took into account reports from the Congressional Budget Office when factoring Fannie and Freddie performance into the outlook revision.

“And adding non-deficit contributions to government borrowing requirements (such as student loans) leads us to expect the U.S. general government deficit plus non-deficit borrowing requirements to fall to about 6% of GDP this year (down from 7%, in 2012) and to just less than 4% in 2015,” said the S&P.

“We now see net general government debt as a share of GDP staying broadly stable for the next few years at around 84%, which, if it occurs, would allow policymakers some additional time to take steps to address pent-up age-related spending pressures,” the analysts conclude.

This has huge implications.  Basically, the Federal Government owns and controls the secondary mortgage market.  If they privatize  Fannie and Freddie then the US credit could be downgraded again, simply due to the decrease of revenue.  In addition, the Feds now have a incentive to compete against private Mortgage Backed Security companies instead of letting these companies assume a much bigger market share.

GSE reform suddenly a pipe dream

Posted by Jacob Gaffney on June 10, 2013 01:38 PM

Right now, Fannie Mae and Freddie Mac are awash in feel-good vibes from Standard & Poor’s. The credit ratings agency reported that the strong performance from both government-sponsored enterprises factored into the decision to revise the nation’s credit outlook upward.

Last month, Fannie Mae reported first-quarter pre-tax net income of $8.1 billion, compared to $7.6 billion from the previous quarter, as a result of strong credit results driven by an improving housing market.

Similarly, Freddie Mac posted first-quarter net income of $4.6 billion, up slightly from $4.5 billion in the fourth quarter of 2012 and the second largest profit in enterprise history.

“Combined with Freddie, which is still analyzing the valuation of its deferred tax position, Treasury will get more than $65 billion this quarter,” wrote Jim Vogel, an analyst at FTN Financial in an email on the earnings. “That is $55 billion more than officially expected and will cramp bill sales even more unless Treasury decides to float a higher cash position through the summer.”

So now that Fannie and Freddie are directly involved in driving investment interests in this nation, how likely can it be that well-minded GSE reform legislation stands a chance of passing into law?

Sen. Bob Corker, R-Tenn., for example, is leading a bipartisan group in the hopes of creating legislation constructed to reform the housing finance system.

Corker’s push on Capitol Hill is a testament to the current sentiment toward government’s dominance in the mortgage market.

But like it or not, Fannie and Freddie are now drivers of growth and investment.

Attempts at GSE reform in the short term now feels destined to fail.

I think most of the politicians are just looking at revenue potential and ignoring the liability of these GSE’s.  First, the reason the government own 79.9% of the GSE’s is that their losses were so huge they had to taken over the US or face bankruptcy.  There is a perception that these bad times are behind us, but 11 million homeowners are still underwater and running out loan modification attempts. In addition, rising mortgages or increasing cost of living could lower home values and push more people into default.

As these GSE’s produce revenue for a federal government that runs annual deficits, one of the few brights spots in the federal budget.   So, how can this not lead to a push to have generate even larger revenue?   This can only be achieved by expanding the GSE’s market, which is difficult when you already have 90% of the market AND the number of purchase and refi loans are decreasing.  To expand the market Fannie and Freddie will need to purchase and guarantee loans to the “underserved” lending market.  For example this could mean expansion into jumbo mortgages, multifamily lending,  or even some type of variable loan that adjust every 5 years.  If this sounds familiar, Fannie and Freddie expanded into subprime (bad credit) lending into the 1990’s before the housing bubble.  And this expansion wasn’t for profit; it was motivated by political interest in Washington.

We also need to discuss the Guarantee fees charged by both Fannie Mae and Freddie Mac.  This fee has been increased several times, which is probably a good thing because it makes private lending more competitive.  However the increased revenue has lead to record profits which was the major factor than caused the upgrade to the US credit rating…making the privatization less of a possibility.  The G-fee is not the only source of revenue there is the mortgage tax which is collected through the G-fee.  This a straight tax that is collected by Fannie and Freddie and sent to the US Treasury.  This tax is only accessed on Fannie and Freddie loans.  It’s another incentive not to privatize Fannie and Freddie and collect this tax.

Finally, the HAMP and HARP programs have also added to profitability of the Government Sponsored Entities.  These programs have resulted in millions of loan modifications.  The affect of these modifications that it delays the loan losses from evidential default of these loans.  Successful borrowers have been able to delay default for years.  Larry Robert’s had a detailed post discussing the non-performing loans owned by the banks.  Some of these loans are guaranteed by Fannie and Freddie and they  will have to pay of the insurance claims to the lenders if they default.   It has delayed the realization of losses on these non performing loans and has increased the profitability and by extension the credit rating of the US.

I’m just speculating but if these entities weren’t so profitable, would privatization be so difficult?  Seems illogical but they are too profitable the Federal Government can’t afford to sell them.  At the other end of the spectrum if there are major losses at Fannie and Freddie due to defaults will privatization even be possible?  It seems that over hang of non-performing loans and underwater loans that easily go into default could kill the profitability of these entities.  In addition, the loses could then negatively affect the credit rating of the US, which is going to happen anyway if sell them.  At least if you sell them you can recoup some money.   In conclusion wouldn’t it be prudent  to liquidate  Fannie and Freddie while they show profits and still marketable, even though the US will take a credit rating downgrade?