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The CBO Takes On Fannie Mae, Freddie Mac Reform

The Congressional Budget Office (CBO) has released a report analyzing the expected costs and consequences of the main alternatives to Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). A lot of its conclusions are straightforward, less government involvement in the secondary mortgage market probably means higher interest rates on home loans, but the CBO disputes the worst-case scenarios put out by some advocates of returning to private GSEs.

“Under any of the transitions that CBO examined, the agency expects that most borrowers would still be able to take out 30-year fixed rate mortgages,” says the CBO report.

Fannie Mae – How CBO accounts for the GSEs

The CBO has taken a different stance on the GSE’s than the Obama administration since the beginning of the conservatorship. The Treasury Department in other parts of the executive branch still treat Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) as external entities and account for dividend payments as income. The CBO accounts for the GSEs according to the rules set by the Federal Credit Reform Act of 1990, which is similar to accrual accounting with a discount for overall market risk. That means the CBO assumes that Fannie and Freddie are already fully owned by the federal government, and that the dividend payments are transfers from one branch of government to another. Since the CBO’s rule is to advise on the cost of different policy decisions, it doesn’t comment on shareholder rights, litigation, or any of the other political wrangling surrounding the GSEs.

On this basis, the CBO says that government support of the GSEs will cost $4 billion in 2015 and $19 billion between 2015 and 2019 in implicit subsidies because that’s the difference between market price and what the agencies are projected to charge for loan guarantees (assuming no policy changes).

Fannie Mae – Reducing GSE market share under the current system

before it delves into alternative structures for housing finance, the CBO points out that the market share of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) is already falling. Even with the VA and the FHA ensuring more mortgages, overall the government’s share of the secondary mortgage market has fallen from 80% in 2013 to 70% in the first half of 2014, and the CBO thinks it will fall to 50% in the next decade without any other changes.

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Even without congressional action, FHFA director Mel Watt can increase guarantee fees, set lower loan limits, or even set Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp’s (OTCBB:FMCC) actual market share with g-fee auctions, selling a set number of guarantees to the highest bidder. An increase in g-fees of 50 basis points over the next 10 years, for example, is projected to cut Fannie Mae and Freddie Mac volumes to about a fifth of the current levels.

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Fannie Mae – Deciding which system we want to have in place during a crisis

Keeping Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) contact isn’t meant to be a long-term plan, and the CBO looks at four alternatives for what could come next: a single federal agency that guarantees eligible mortgage-backed securities, a hybrid system with private investors in the government share credit risk with private investors in the first loss position, mostly private secondary market with the government playing role of guarantor of last resort who only guarantees mortgages during the credit crunch to prevent the housing market from collapsing, or a fully private secondary market with no federal involvement.

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“Each of those four market structures would have its own advantages and disadvantages in the following areas: ensuring a stable supply of financing for mortgages, protecting taxpayers from risk, providing incentives to control risk taking in the mortgage finance system, and making the allocation of credit risk between the government and the private sector transparent,” says the report.

Without even getting into specifics the fourth option has a credibility problem, it doesn’t seem politically feasible for the government to sit back and do nothing the next time we had a housing crisis. A single federal agency sounds a lot like a common securitization platform (CSP) currently being developed by Watt, the hybrid system is basically the Crapo Johnson plan that failed to get Congressional support earlier this year, and the guarantor of last resort is basically the realistic version of the free market approach advocated by Representative Jeb Hensarling and other far right conservatives.

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What’s striking is that the CBO seems to think that the differences between these plans isn’t that significant is always the market is stable. Less government involvement means higher interest rates, which also translates to lower housing prices, but it argues that 30 year fixed-rate mortgages will mostly still be available for slightly to moderately higher rates. The bigger question seems to be, what kind of system do we want to have in place during the next crisis.