Fannie Mae-No Politics (FNMA)

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Envisioning a Fannie and Freddie Endgame

Fannie Mae and Freddie Mac can only be dealt with through a comprehensive solution
that takes into account the interests of homeowners


Fannie Mae headquarters in Washington PHOTO: KEVIN LAMARQUE/REUTERS
By AARON BACK ... Updated Jan. 4, 2017 12:30 p.m. ET

The question of what to do with Fannie Mae and Freddie Mac has bedeviled investors and politicians ever since their crisis-era bailout. Donald Trump’s election, and comments by his pick for Treasury secretary, have raised hopes of a solution.

That has investors who believe they were unfairly treated by the government excited. Yet, while they might benefit from a solution, their demands are unlikely to be considered until a feasible plan that shores up the U.S. housing market is on the table.

Proposals that have been floated in Washington vary from purist visions of free-market housing finance to plans for an outright government guarantee on most mortgages. Little is known about how the new administration views Fannie and Freddie, but if they do tackle the issue, it is likely they will approach it pragmatically rather than ideologically.



One compromise proposal stands out for its potential to achieve broad consensus—essential to avoid a potential Democratic filibuster in the Senate. A bill written in 2014 by Republican Senator Mike Crapo of Idaho and former Democratic Senator Tim Johnson of South Dakota was supported by a bipartisan majority in the crucial Senate Banking Committee.

The Johnson-Crapo bill would wind down the companies and transfer much of their infrastructure to a new securitization platform cooperatively owned by market participants. The mortgage-backed securities issued by the platform would have explicit federal guarantees through an agency modeled after the Federal Deposit Insurance Corp. To introduce private capital into the system, outside investors would be paid to shoulder the risk of the first 10% of losses on mortgage pools before federal insurance kicks in.

Fannie and Freddie are already running trials that transfer some risk in their mortgage portfolios to outside investors. Since 2013, investors have purchased risk-transfer securities from the two companies covering $1 trillion worth of collateral, notes Bonnie Wongtrakool, a fixed-income portfolio manager at Western Asset Management.

This plan doesn’t address demands by current Fannie and Freddie shareholders to end the “profit sweep,” by which their quarterly profits go straight to the government. This arrangement, put in place by the Treasury in 2012, is the subject of multiple lawsuits arguing it amounted to unilateral government expropriation.

But ending the profit sweep and allowing the companies to rebuild capital would put them on one of two paths, both undesirable for policy makers. They could emerge as they were before the crisis, though in a safer, less leveraged form. But this wouldn’t resolve the issue of their implicit government guarantee. Or they could become completely independent of the government, which would likely raise the cost of mortgages—an outcome no one in Washington wants to see.


A comprehensive approach along the lines of Johnson-Crapo addresses these problems head on. To appease current investors in Fannie and Freddie, the companies could potentially fill the role seen for the securitization cooperative. Investors could retain equity ownership and a share of profits in reformed, highly regulated companies that would act like public securitization utilities.

To politicians and policy makers, the need for a stable housing finance system that works for most Americans will outweigh the demands, no matter how loud, of Fannie and Freddie shareholders. These investors have a seat at the table, but they shouldn’t waste it by ignoring the most important questions for these two companies.

Write to Aaron Back at [e-mail]