Over the weekend the Wall Street Journal put out an editorial extolling the CBO for “showing how easily the U.S. could transition to a free market that doesn’t threaten taxpayers” by eliminating Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and getting out of the mortgage market entirely. The editorial was sure to anger Fannie Mae longs (it has), and shows how differently the two sides of this debate view the role of the GSEs.
Fannie Mae: Bove calls out WSJ for ‘fundamental lack of knowledge’
The main question for policymakers and for Main Street is whether Fannie Mae and Freddie Mac are necessary to ensure that Americans have access to 30-year mortgages. The CBO report claims that they aren’t: it says that access wouldn’t drop significantly and interest rates would go up by about 60 basis points.
“Under the scenario sketched out by CBO, as the toxic twins disappear, private investors could once again take a leading role in the market,” writes the Wall Street Journal, not bothering to hide their longstanding disdain for Fannie Mae and Freddie Mac.
“For a decade, the reporting related to the mortgage markets has demonstrated a fundamental lack of knowledge as to how these markets and housing operates,” Rafferty Capital Markets LLC VP of equity research Richard Bove responds. Calling out WSJ specifically.
Bove points out that when the private sector wanted to take market share from Fannie Mae and Freddie Mac in the years preceding the financial crisis, it simply did so. After the financial crisis, the private market left and the GSEs took up the slack. The CBO assumes private capital would return if the GSEs were shut down, but it doesn’t have any evidence that large investors are interested in the kind of credit and interest rate risk that long-term, fixed rate mortgages entail.
CBO assumes private sector is waiting to rush into the mortgage market
On the other hand, Bove claims that investing in Fannie Mae and Freddie Mac has been a windfall for taxpayers because the government has paid in a total of $189.4 billion, and received cash payments worth more than $200 billion alongside their preferred stocks that are still worth the amount paid in at par value (and probably a lot more at market value if the GSEs were released from conservatorship).
The CBO says that the GSEs are cash flow positive but operating at a loss. Its reasoning is that if Fannie Mae and Freddie Mac were pricing guarantee fees at market value they would face stiff private sector competition; since the competition isn’t there, the g-fees must be too low (this is the implied subsidy you often read about), and the difference is recorded by the CBO as a loss. Again, the CBO’s underlying assumption is that the private market wants to take on the risk associated with 30-year mortgages, but if that isn’t true then the conclusions it draws aren’t either.