The Future of Fannie and Freddie

As the administration, the Federal Housing Finance Agency—which controls the GSEs—and the private sector, which is frothing for more multifamily exposure, prepare to square off, Fannie and Freddie’s destiny hangs in the balance yet again.

A PR Problem

While primarily known for their programs that help individuals finance single-family home purchases, less familiar, but perhaps as important, is Fannie and Freddie’s multifamily lending platform, which is used to build and maintain much of America’s workforce housing.

Observers in both parties readily admit that Fannie and Freddie make tremendous amounts of money from their multifamily businesses, which even in the recession’s darkest days, did not see significant losses. But, alas, because the two are so tightly bound, multifamily lending is dragged down along with the once-troubled single-family mortgage business in discussions of how to further privatize—or at least involve more private money in—agency lending, while simultaneously preserving liquidity, or at least not creating market-halting liquidity shocks.

“It’s a sector that doesn’t really deserve to be in conservatorship,” said Lisa Pendergast, the executive director of the Commercial Real Estate Finance Council, of the multifamily side of agency lending. “Since we started talking about what to do with the GSEs…[politicians] spend 98 percent of the time talking about single family, and then they throw in multifamily because it performs so well.”

But the single-family platform’s nagging public relations problem is also the commercial finance business’s. Both could be privatized, following a brief capital raise, if a new plan pushed by investors like John Paulson, the president of hedge fund Paulson & Co., who also has President Donald Trump’s ear, were implemented. Those who’ve seen this discussion play out before are skeptical—both about the decision to privatize the agencies and the likelihood it is politically possible.

“It’s risky business to privatize because, if it’s not done smartly, it’s going to increase the cost of borrowing,” said Robert Ivanhoe, the co-chairman of law firm Greenberg Traurig. “A lot of people could lose a lot of money because of the change in spreads.”

Of course, if done effectively, there are plenty of private lenders who would like to take a larger piece of the multifamily lending pie—an area where it’s hard to compete with the 4.25 or 4.5 percent interest rate on a 10-year loan that Dan Brendes, a managing director with mortgage lender Berkadia, estimates borrowers are currently getting from Fannie.

But Fannie and Freddie have been on the block—to varying degrees—before. In 2014, a Republican bill was before the Senate Banking Committee asking for Fannie and Freddie to be moved out of conservatorship and be instead backed by an entity more like the Federal Deposit Insurance Corporation. But, just as in the many other instances where politicians have called for the agencies to be rolled into new entities, or even be abolished altogether, the bill went nowhere.

GSE reform is hard for any Democrat to visibly waver on because the GSEs have been a singular engine behind expanded lower- and middle-class home ownership since the end of World War II. On the Republican side, leaders disagree about how to go about it. Treasury Secretary Steven Mnuchin has said the matter of Fannie and Freddie’s future will be a focus of the new administration later this year. But what form that focus will take is still unknown.

Skin in the Game

The GSEs are complicated entities, which makes them hard for politicians and their constituents to parse. But their complexity doesn’t keep them from becoming a political target for those who would like the government out of the business of guaranteeing loans.

The agencies do not actually originate loans themselves but rather pool mortgages from primary lenders, which are in turn securitized. Unlike standard mortgage-backed securities, agency-issued bonds are essentially guaranteed by the government. A 2012 amendment to the agreement between the U.S. Department of the Treasury and Fannie and Freddie capped the losses the government would take in the event of the agencies’ failure at $258 billion, according to Bloomberg News, but the bonds are treated as de facto government-backed.

Last week, the conversation began anew when a proposal that Ivanhoe calls “an opening salvo” was revealed: an administrative fix to what has so far been a very hard-to-legislate issue. Investment bank Moelis & Co., with support from companies like Blackstone and Paulson & Co., put forward a blueprint to recapitalize both GSEs and release them from conservatorship without putting the matter before Congress, as Bloomberg News first reported. 

But observers say the likelihood the Moelis plan moves ahead quickly is low. A spokeswoman for the Federal Housing Finance Agency told Bloomberg that the FHFA still believes that Congress should decide and that FHFA Director Mel Watt would not consider the blueprint. 

“It wouldn’t surprise me if something doesn’t happen until Watt’s term is up,” Pendergast said. And pushing the plan forward without Watt’s support would ruffle feathers, to say the least.

“It is odd that for years Republicans were criticizing [President Barack] Obama for not going through Congress,” Barney Frank, former Massachusetts representative and an author of the Dodd-Frank Wall Street Reform and Consumer Protection Act, told Commercial Observer. “Why are they doing [this] by executive fiat?”

Beyond the political issues, there are also budgetary and logistical hurdles to recapitalizing the GSEs. A principal at a major nonbank lender, who asked not to be named, raised an important question: Where would the money come from? If not provided by the government, what would incentivize private sources to hand over money to the agencies before the privatization has even happened? And if Fannie and Freddie simply stopped providing revenue to the federal government, to shore up capital for their privatization, what affect on the government’s budget would that have?

Proponents of the Moelis blueprint say it returns $100 billion to taxpayers, according to Bloomberg, but did not specify over what period of time the figure refers to. Representatives for Fannie and Freddie did not respond to requests for comment for this story.

Moreover, the assertion that privatizing the GSEs returns money to taxpayers arguably obscures the issue of to whom those profits would then fall.

“I’m sure there is some self-serving reason that hedge funds like [Paulson & Co.] are supporting this,” Ivanhoe said. Paulson & Co. reportedly owns stock in Fannie and Freddie.

One also assumes since multifamily agency lending “has become massively profitable ever since about 2010,” according to Ivanhoe, any investor with a debt platform wants in on that. An executive with a major lender said he believes “30 to 40 percent of the institutional investor asset class” is regularly relying on agency financing. 

The biggest winners from a retreat by agencies? Life insurance companies and CMBS investors who want more exposure to multifamily, according to the executive, who asked not to be identified.

There’s also the issue of whether or not the U.S. government has made back what it spent propping up the GSEs and paying their bondholders in 2008 and 2009. The widely quoted number for the cost of their bailout is $187.5 billion, which would mean they have repaid the debt many times over, sources said.

Another Option?

While much of the business community is amenable to GSE reform, there is little agreement on how it should work. The prominent industry group the Mortgage Bankers Association doesn’t think the Moelis blueprint goes far enough and the organization’s president told Bloomberg the proposal was “self-serving.”

The MBA has its own reform proposal, which suggests that the government “replace the implied government guarantee of Fannie Mae and Freddie Mac with an explicit guarantee at the mortgage-backed security level only, supported by a federal insurance fund with appropriately priced premiums.”

The MBA proposal also suggests that Fannie and Freddie’s successors, created by the government, be the first guarantors for securities they handle. Then a regulator would be empowered to charter other guarantors, somewhat similarly to how public utilities are treated by the government. The guarantors would issue MBS, hold some mortgages on their books and use reinsurance and other instruments to hedge risk. The regulator would calculate an appropriate risk appetite for the guarantors. The backstop federal insurance fund would only kick in if a guarantor failed and all private capital in the stack “had been exhausted,” the MBA proposal says.

In recent years, informal proposals have also been floated to roll together Fannie and Freddie into one GSE and to separate the multifamily lending platform from the single-family mortgage platform, Pendergast said. Those provisions could still be on the table as the conversation around GSE reform evolves.

First Shots Fired

But whichever tack the administration takes on the thorny issue of changing the ownership structure of these large and complex institutions, one thing is for sure: The ball is now officially rolling, and what aspects of Fannie and Freddie’s business are changed—and how—is a matter of concern to borrowers and lenders. As mission-driven enterprises, the GSEs facilitate lending for affordable housing and for green building and retrofit. Both of those objectives could be under fire with the proposed changes, although the Moelis plan says the agencies would continue to promote affordable housing if adopted.

Right now, Fannie and Freddie offer lower rates for multifamily projects with an affordable component or those that make commitments to reduce energy or water consumption.

“Fannie stipulates that if the borrower commits to a scope of work to reduce the water consumption by 20 percent,” they can receive a discount of about 39 basis points on a loan with a 30-year amortization, said Tony Liou, the president of energy consultant Partner Energy. For Freddie Mac loans, the commitment is 15 percent reduction for a discount of between 10 and 20 basis points, often, he said.

While Freddie’s green lending platform is new, Fannie has been originating loans with green requirements for about four years, Liou said.

The focus on lending through the green programs is partially because such loans do not count toward the cap—$36.5 billion annually—of loans Fannie and Freddie can close. In encouraging more owners to get the discounts, they increase their total volume and fulfill their mandate.

The green financing platform has proved very popular with lenders and borrowers. “We are utilizing green every opportunity we get,” Brendes said. “It’s some of the best pricing in the market.”

Asked if he worries the green program will be targeted by the reform plans, Liou said he “thinks it would be myopic to do so,” but it is possible.

Affordability is a different beast, although one in which other players, such as the U.S. Department of Housing and Urban Development, are also involved.

Ivanhoe, Frank and Brendes said they worry about a loss of liquidity and increased cost of capital for some multifamily borrowers in the event of privatization. The age of American housing stock and the demographic strains on it—as millennials live in rental housing longer—make the supply and maintenance of affordable housing even more important, they said.

“GSEs right now are focused on workforce housing,” Brendes said. He said he worries about how new affordable housing will be built if drastic changes to the GSEs are implemented. “It’s very challenging to build [affordable housing] today.”

Some in the commercial finance world do want reform but urge caution.

“I think there’s support for bringing them out of conservatorship,” Pendergast said. But, “it’s more about finding a strategy” to do so that that preserves liquidity.

All sides of the discussion continually repeat one strain: Do this with haste, and you risk cratering a market that is vital for Americans’ housing and many firms’ business.

Frank said he doesn’t believe any recapitalization and release would serve the borrowers Fannie and Freddie are supposed to, though he was quick to add that he’d not been briefed on the Moelis plan. If loans continue to have 30-year terms, something is needed to “provide some mechanism whereby people can buy a reasonably priced hedge against dramatic interest rate fluctuation,” he said.

Ivanhoe was more direct: “What’s best for the real estate industry? Leave it alone.”