Moody’s Report: ‘Time to Wind Down Fannie and Freddie’

Published May 13, 2014

Moody’s Investors Service says it is “time to wind down” Fannie Mae and Freddie Mac. The declaration appears in an in-depth analysis of the Johnson-Crapo Finance Reform and Taxpayer Protection Act that was presented in May at a Federal Reserve Bank of Chicago annual bank structure conference. The bill aims to wind down Fannie Mae and Freddie Mac and replace them with a new government agency.

Senators Mike Crapo (R-ID) and Tim Johnson (D-SD) introduced the bill earlier this year. It is awaiting markup.

“It is time to wind down Fannie Mae and Freddie Mac and reform the housing finance system. Since the government took [them] over during the financial collapse more than five years ago, nothing has changed. The government is still making nine out of every 10 loans, amounting to almost $1 trillion annually,” wrote Moody’s Chief Economist Mark Zandi and Senior Director of Consumer Credit Analysis Cristian deRitis in their analysis.

Taxpayers are underwriting this debt even though private investors want to undertake the risk and include some safeguards, according to Zandi and deRitis.

Cash Cows

Another problem with Fannie Mae and Freddie Mac staying in government hands, according to Moody’s, is the threat they will be used for purposes outside of housing. For example, the 2012 payroll tax rollback was funded partially by raising premiums Fannie and Freddie charge homebuyers for insurance. These higher premiums will continue over the next decade.

In the same vein, according to Moody’s, policymakers may begin to rely on these profits to fund future government spending. If this happens, it would be harder to shutter the government-sponsored entities.

Their uncertain future is also contributing to tight credit, according to Moody’s. On the other side of the coin, “politicians may be tempted to force Fannie and Freddie to lend to people who really cannot afford mortgages . . . Experience shows that politically driven help can be misdirected or abused.”

The Moody’s analysis further says government rules to protect the financial system against another housing industry collapse have gone too far, with capital requirements more than double what insurers lost in the Great Recession.

Phasing Out Fannie, Freddie

The bill Johnson-Crapo bill has the following basic provisions:

  • Private financial institutions must put up 10 percent in first-loss capital to qualify for the government guarantee, using a combination of insurance, letters of credit and future guarantee fees.
  • A new regulator, the Federal Mortgage Insurance Corp., would oversee the insurance, securitization and insurance of mortgages. The FMIC would replace the Federal Housing Finance Agency to oversee all aspects of the mortgage finance market.
  • Freddie and Fannie would be wound down, and so would the government’s role in housing. The term of the wind-down is initially slated at five years, but the legislation also includes provisions to extend this time.
  • There would be a common securitization platform that the FMIC would guarantee. Standardization would make it easier for investors to compare the different investment pools, according to Moody’s.
  • The bill eliminates housing goals now required for the GSEs. Instead, there would be a few different funds to address affordable housing and home ownership. To avoid any conflict between providing liquidity for the mortgage market and promoting home affordability, the legislation would create two funds with different mandates, according to Moody’s. The bill also preserves consumers’ ability to lock in interest rates before closing while also ensuring the availability of 30-year mortgages.
  • To ensure community banks and credit unions have access to the secondary mortgage market, the proposed legislation would establish a mutually owned cooperative of small lenders that would provide access to the secondary market as well as securitization services.

Fixable Flaws

“There is a lot to like in the Johnson-Crapo vision of the housing finance system, but it falls short in some important, yet readily fixable respects,” the Moody’s analysis says.

Under the proposed legislation, financial institutions could originate, aggregate, securitize and guarantee loans. It would be better, according to Moody’s, if the legislation “made a clear break between guarantors and originators: Financial institutions should be one or the other, not both.”

Another concern for Moody’s is that the legislation would allow capital markets to compete with guarantors, which could be destabilizing.

Moody’s acknowledges political divisions in Congress make it unlikely housing reform will pass this year – a sentiment echoed in an American Banker article in mid-May — but adds that failure to wind down Fannie and Freddie and set up a new housing finance system is a large piece of unfinished business for housing reform.