Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have dominated the debate on how the government should support the housing market with banks, affordable housing advocates, private shareholders and free market purists all pushing their point of view. But alongside this tangled conversation, Ginnie Mae has tripled its mortgage-backed security (MBS) portfolio from less than $500 billion at the start of the financial crisis to $1.5 trillion last month, earning a profit every year for the last two decades, and is now building the groundwork to become even larger. Could it eventually fill the gap left behind when Fannie Mae and Freddie Mac or wound down?

“Ginnie Mae should certainly be part of the conversation,” says Ginnie Mae president Ted Tozer in a telephone interview with ValueWalk.

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Ginnie Mae’s role in the TBA market

Ginnie Mae actually issued the first MBS back in 1968 shortly after Congress split it off from Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) so that they could play distinct roles in the market. Fannie Mae was to continue buying mortgages directly while Ginnie Mae only provided insurance for bonds, and while there is more overlap between their activities today their still an important difference between the bonds that they issue.

When an investor decides to buy a MBS on the to-be-announced (TBA) market, they only get to specify six characteristics as part of the deal: issuer, maturity, coupon, price, par amount, and settlement date. Other details won’t be available until 48 hours before the trade is settled, and much of the time the mortgages don’t even exist when the deal is struck. The benefit to mortgage originators is clear, by setting terms on the TBA market before they actually make home loans they pass the interest rate risk on to someone else. Capital markets get access to high quality bonds that are fungible because of the government guarantee, explicit in the case of Ginnie Mae and implicit for Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). The dearth of private label MBS after the financial crisis while agency MBS issuances are regularly oversubscribed shows just how important the government guarantee has become for investors.

When Ginnie Mae securitizes mortgages it first requires them to be insured by the FHA, the VA, or a handful of other government agencies and then sets up a pass-through security that guarantees payment from the mortgage issuer to the bondholders. The big advantage of this setup over the Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) model is that Ginnie Mae is guaranteeing securities against the loan issuers, not the loans.

That means a Ginnie Mae security backed by Wells Fargo won’t fail if too many loans go into default, as happened with so many Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) MBS during the financial crisis, it only fails if Wells Fargo & Co (NYSE:WFC) itself goes bust. Ginnie Mae stands in the fourth and last loss position after the home-buyer, government insurance, and the mortgage lender, while bondholders will get paid regardless.

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‘Ginnie Mae can be scaled up almost indefinitely’: Tozer

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) operated for years as private corporations with implicit government guarantees, a classic example of moral hazard that encourages risky behavior. A combination of government pressure to expand affordable home mortgages and the GSE’s desire to increase market share in the late 90s led to looser underwriting standards, contributing to the eventual housing bubble. After the government bailed out the GSEs to the tune of $187 billion, many concluded that the arrangement was untenable and the GSEs would have to be shut down.

“I think what we’re seeing is a model shift, Fannie Mae and Freddie mac will eventually be replaced by something like the structure that was proposed in Crapo-Johnson,” says Tozer.

But Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) supporters argue that this would undermine home ownership and kill off the 30-year mortgage. The basic tension in the GSE reform debate is between the often conflicting goals of providing affordable housing and avoiding another taxpayer bailout. That’s why the Crapo-Johnson proposal, which tried to balance the two, was attacked from both sides of the aisle, though Tozer rejects the idea that we can’t have both.

Crapo-Johnson would create a new federal agency called the Federal Mortgage Insurance Corporation that supervises a common securitization platform and stands in the last loss provision behind the homeowners, the mortgage issuers, and mortgage reinsurance, which sounds a lot like what Ginnie Mae is already doing but with almost half a century of institutional experience behind them.

“Ginnie Mae can be scaled up almost indefinitely without putting taxpayers at additional risk,” says Tozer, and he’s preparing the agency for just that possibility. Cutting edge IT infrastructure, better business processes, and a bigger workforce to keep pace with Ginnie Mae’s growing portfolio, and he doesn’t sound like he’s ready to stop at $1.5 trillion.