A U.S. Senate plan to dismantle Fannie Mae (FNMA) and Freddie Mac (FMCC) may deliver an unintended blow to a fragile housing recovery.
A draft of the measure, which Senate Banking Committee leaders released Sunday, would replace the two financiers with a government-backed mortgage-bond insurer. Private interests would be required to bear losses on the first 10 percent of capital, leading to higher mortgage rates, according to Credit Suisse AG analysts. The plan also would eliminate a mandate that a percentage of mortgages go to lower- and middle-income families, threatening to decrease America's homeownership rate.
Sen. Tim Johnson, a Democrat from South Dakota, and Sen. Mike Crapo, an Idaho Republican, are trying to pass the measure this year. Outside the Senate chambers, the housing market is showing signs of cooling as tighter lending and higher prices shut out increasing numbers of first-time buyers.
"It certainly slows the rate of recovery," said Kevin Chavers, a managing director at BlackRock Inc. and a member of its government relations and public policy group in New York. "It raises the question of what the implications are for the recovery as you raise costs and reduce the universe of people eligible to participate."
Fannie Mae was established in 1938, near the end of the Great Depression, to boost homeownership by making mortgages more available for low- and moderate-income borrowers. Along with the smaller Freddie Mac, created in 1970, the company bundles loans into mortgage-backed securities that are sold to investors with the support of the government.
Federal officials steadily increased the firms' mortgage origination goals during the Bill Clinton and George W. Bush administrations. By 2008, the government's mandate to reach low-and moderate-income families peaked, an aim made possible by lenders peddling riskier loans.
During the housing crash, the surge in defaults almost sunk the companies and regulators seized them in 2008. The two firms received $187.5 billion in taxpayer funds over the next three years. And the Federal Housing Finance Agency lowered the firms' mortgage origination goals. It took about three years for Fannie Mae and Freddie Mac to earn profits again.
President Barack Obama and Democratic and Republican lawmakers want to wind down the two companies, shrink the government's influence in the market and bring in more private capital to create a less risky housing finance system.
Crapo told Bloomberg Television last week that it's important to avoid the toxic mortgages that pushed the country into financial crisis.
"There probably will be a little bit of additional cost in some senses, but there will be actually savings and efficiencies in other contexts," Crapo said. "What we're putting together is at the front end of everything a strong underwriting system so there will have to be buyers with the ability to repay."
The Senate plan's requirement that the industry absorb the first 10 percent of mortgage losses would be a challenge for the market, Credit Suisse (CSGN) analysts led by Mahesh Swaminathan said in a report last week. Additional insurance fees for the holders of the mortgage-backed securities could lead to "sharply higher" mortgage rates, Swaminathan said.
The draft legislation calls for the dismantling of Fannie Mae and Freddie Mac over five years, which could be extended to prevent market disruptions, such as spikes in borrowing costs, according to a statement Sunday.
Rates for 30-year fixed loans climbed to 4.37 percent last week from a near-record low of 3.35 percent in early May. The rate reached a two-year peak of 4.58 percent in August.
Jeffrey Gundlach, chief executive officer of Los Angeles-based DoubleLine Capital LP, said the 10 percent rule would result in lenders further limiting risk.
"When you're asking or hoping for private money to take the loss risk, they're going to understandably want tighter underwriting or else the rate would have to be really high," said Gundlach, whose $32 billion DoubleLine Total Return Bond Fund invests in mortgage-backed securities. "At this point, tighter underwriting is more attractive than much higher mortgage rates."
Tougher credit standards and property prices, which are up 24 percent since their March 2012 low, already are posing obstacles to homeownership. More than 40 percent of borrowers in 2013 had FICO scores above 760, compared with about 25 percent in 2001, according to a Feb. 20 report by Goldman Sachs Group Inc. analysts Hui Shan and Eli Hackel.
First-time buyers accounted for 26 percent of purchases in January, down from 30 percent a year earlier, according to the National Association of Realtors. This January's figure is the lowest market share NAR has recorded since it began monthly measurements in October 2008.
That's hurt U.S. sales. While purchases rose 8.2 percent for residences costing more than $250,000, they fell 10.7 percent for homes worth less, NAR data show.
The share of Americans who own their homes was 65.2 percent in the fourth quarter, down from a peak of 69.2 percent in 2004, according to the Census Bureau. Minority groups were heavily impacted by the housing crash: the homeownership rate for blacks fell to 43.2 percent in the quarter from 44.5 percent a year earlier and are down from 50 percent before the housing meltdown.
"You have the unusual situation that the segment of the population hardest hit by the foreclosure crisis is the one that's going to find it most difficult to rebuild in the aftermath," said Lautaro Diaz, vice president for housing and community development at the National Council of La Raza, a Washington-based Hispanic civil rights and advocacy organization.
The Senate proposal seeks to bring more buyers into the market by creating affordable housing funds. The industry would pay into funds that would be devoted to ensure affordable rental and for-sale housing is available. A 0.1 percent fee would be charged on mortgage-backed securities, which could add up to about $5 billion a year based on current volumes. Senators haven't worked out the details of how the housing funds would be used.
Anthony Sanders, a professor of real estate finance at George Mason University, supports provisions of the Senate plan to limit homeownership. He said the housing goals embraced by Clinton and Bush were responsible for inflating the bubble and should be eliminated.
"The housing bubble so decimated the middle class that they maybe can't come back into the housing market," Sanders said. "If suddenly incomes start surging, then we should really have to reconsider affordable housing goals one more time. Right now, it does moderate income and lower income households a disservice to try to encourage them to purchase."
The bill would attract more private capital into the housing market and improve credit availability, said Jerry Howard, chief executive officer at the National Association of Home Builders. Howard, who supports the proposal, said investors are avoiding the housing financial system because Fannie Mae and Freddie are in conservatorship and subject to the whims of politicians.
"If you're an investor, would you rather do business with an entity that has concrete rules that govern its operations or an entity run by the political system," Howard said. "The answer is clear and that's why credit is sporadic right now."
The plan, which was drafted with input from the Obama administration, has yet to gain the backing of Senate Democratic leaders, who will determine whether it gets a vote. Senators Johnson and Crapo plan to hold a committee vote in coming weeks, and are pushing to pass their proposal this year before mid-term elections in November.
White House spokesman Bobby Whithorne said that the administration supports the Senate proposal.
The companies will have returned $202.9 billion to Treasury by the end of this month -- exceeding the size of the bailout. The funds are counted as dividends on the federal investment, not as a repayment of the aid, leaving Fannie Mae and Freddie Mac no avenue for exiting U.S. control.
Democrats such as Sen. Elizabeth Warren of Massachusetts have said they won't back a plan to replace the mortgage giants unless it guarantees affordable loans for most homebuyers and includes significant support for low-income rental housing.
"With a fragile housing market, it does raise questions about whether this is the time to shake the whole thing up," said Mike Calhoun, president of the Center for Responsible Lending, a consumer group in Durham, North Carolina.