In the run up to the US housing crisis you would have liked for government agencies to know better than to get involved in subprime mortgages and other risky assets, but in fact Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and the Federal Housing Agency (FHA) found themselves competing for high risk debt in the secondary mortgage market.
Now the question is how those same government agencies can balance their mission of supporting low-income housing without exposing taxpayers to too much risk, and according to FedFin managing partner Karen Petrou argues that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are re-creating this race to the bottom with their new high loan-to-value mortgages.
“As the largest U.S. Government mortgage guarantor, [FHA] is meant to play a targeted policy role: supporting low- and moderate income borrowers, especially first-time ones, not eligible for private-sector mortgages, including those purchased by Fannie Mae and Freddie Mac. For there to be affordable housing, there needs to be FHA,” writes Petrou in a November 14 note.
How Fannie Mae’s high LTV loans impact FHA
Petrou argues that FHA is faced with two unattractive options. First, FHA can drop its premiums to better compete with Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), but that means taking in less revenue and underpricing the risk on its books. Second, it can try to hold the line and price risky loans appropriately, but then Fannie and Freddie will be able to adversely select the loans that go to FHA and FHA will still end up with riskier assets on its books and (again) lower revenue as its market share falls, the option it chose last time around.
Next Congress will have to confront the difficulties of GSE reform
Petrou would like to see FHA refocused on its mission of providing support the first time in low income homebuyers but the dilemma that FHA is facing shows the difficulty in balancing affordable home ownership with reducing taxpayer risk. With the new Senate getting ready to take office, and Sen. Shelby expected to be the next chairman of the Senate banking housing and urban affairs committee, Petrou expects to see action on both FHA policy and GSE reform generally, but finding a middle ground that can both pass Congress and get the president’s signature seems unlikely.