- When the housing market began its epic and historic free-fall in 2008, mortgage giants Fannie Mae and Freddie Mac faced imminent collapse.
- The Treasury Department stepped in with a major bailout that July. And it turned out to be a vastly profitable move for Uncle Sam. The move has been paying off ever since.
- Indeed, the bailout of Fannie and Freddie saved the housing market, but the two are still under government control, and now the question is how to get them out.
When the housing market began its epic and historic free-fall in 2008, mortgage giants Fannie Mae and Freddie Mac faced imminent collapse.
Outstanding loan portfolios of approximately $5 trillion were in danger of default, and debate raged over whether to save the institutions that owned or guaranteed about 40 percent of all home loans and helped so many average Americans buy residences.
The Treasury Department stepped in with a major bailout that July. That turned out to be a vastly profitable move for Uncle Sam. And it has been paying off ever since.
"The most amazing thing is that the housing market not only survived, but thrived coming out of the crisis," said Jaret Seiberg, financial services and housing policy analyst for Cowen Washington Research Group. "What the government did actually worked."
But a decade later, the two are still under government control. Now the question is how to get them out.
After the bailout, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into government conservatorship — that is, it took them over, which it had authority to do as their regulator.
Then-Treasury Secretary Henry Paulson called the unprecedented action a "time out" for the two government-sponsored entities, which were then infused with billions of dollars to back their ailing home mortgage portfolios.
The bailout gave Fannie and Freddie the financial liquidity they needed to survive, but also required them to pay the Treasury a 10 percent dividend as part of the deal.
In 2012, when the two were profitable again, Treasury and FHFA revised the agreement, with the former getting all profits on a quarterly basis. In 2017, Treasury and FHFA agreed to allow Fannie and Freddie to maintain $3 billion in capital, before having to pay the remainder of their profits to Treasury.
As a result of the bailout, Fannie and Freddie continued to back loans and now, along with FHA, they back the vast majority of new home loans. Investors continued to buy the mortgage backed securities from Fannie and Freddie, because they were backed by the government, and the housing market began to recover.
"If anyone had said that they saw this back in 2008 or 2009, I think they're kidding themselves," Seiberg said.
Home prices nationally fell 27 percent from their peak in 2006, the height of the housing boom and its reckless lending environment, to their trough in 2012. Prices are currently nearly 11 percent higher than their 2006 peak, according to the S&P CoreLogic Case-Shiller Index.
In some markets, however, the roller coaster was and is far more dramatic. In Las Vegas and Phoenix, heavy investor markets during the boom, homes lost more than half their peak value and have still not fully recovered.
In the first few years of conservatorship, as home values plummeted and foreclosure rates spiked, Fannie Mae drew $119.8 billion and Freddie Mac drew $71.6 billion from the Treasury to stay afloat, according to quarterly filings.
Eventually the handout turned into a handsome profit for the U.S. government. So far, Fannie Mae has paid $167.3 billion and Freddie Mac has paid $112.4 billion. Add it up, and the two drew $191.4 billion but paid $279.7 billion, a net profit of $88.3 billion — and they continue to pay.
"The taxpayers were the ultimate vulture investors here. We bought low when nobody else would come in, and as a result the taxpayers are reaping the reward," said Seiberg. "So this has been a great deal for taxpayers."
The money goes into the general Treasury funds reducing the amount the government has to borrow each year. This, some argue, is why Congress has been slow to reform the mortgage market and take the two out of conservatorship.
The biggest losers in the story are shareholders of Fannie and Freddie stock. Many of them invested after the conservatorship went into effect and they are holding virtually worthless paper. They have challenged the dividend sweep in court, but so far to no avail.
Some say that's a good thing. "Forget shareholders, forget stock speculators, for the rest of the marketplace, the one thing that is keeping [interest] rates lower than they'd otherwise be is this conservatorship," said Dave Stevens, who recently retired as president and CEO of the Mortgage Bankers Association.
"I think global investors, if they're going to invest in a triple A MBS [mortgage-backed security], they want to know there is a government backstop behind it. Without that and without some true reasonable pathway forward, I think we see rates hiccup in any other action that takes place," he added
But Fannie and Freddie cannot stay in conservatorship forever, and, according to Stevens, have the biggest chance of change with a new FHFA director. Current director Mel Watt's term ends in January, but he has been mired in personal scandal, with a former employee accusing him of sexual misconduct, so he could leave earlier.
"One thing that has protected the status quo has been Mel Watt. That is the only thing protecting the current structure of these companies," said Stevens.
If the administration were to replace him with a strong Republican ideologue who tries to shrink the two substantially, Democrats would have new energy for reform. If Democrats should win back power in Congress this fall, reform could move back up on the agenda.
"If the House flips Democrat, then you have [California Democrat] Maxine Waters now getting bombarded by the housing constituency, maybe she starts pursuing GSE reform," Stevens said, referring to government-sponsored entities. "It will be an interesting period going forward."
Even though Fannie Mae and Freddie Mac are profitable, the government is still on the hook, so it's still at risk. In fact, the Congressional Budget Office recently put out a report arguing that eliminating the government-sponsored entities would actually save money because it would rid the government of its risk. But what about the risk to the housing market itself, which is finally thriving again, despite a severe shortage of homes for sale?
"Indefinite conservatorship is the biggest risk to housing today," said Seiberg. "Nobody knows what an administration will do, politics are changing all the time, you have some conservatives who simply want to get the government out of housing, you have some Democrats who want to further involve the government in mortgage rates and mortgage pricing. This is too much uncertainty."
The problem is that the system works well enough that nobody is willing to take the political risk to change it, he added.
And mortgage rates continue to be attractive, as lending begins to loosen up from its tight vice following the crisis.
"So 2009 through 2012 was probably one of the most difficult times to get mortgage financing, by way of credit score, by way of strict debt-to-income ratio calculation, and a whole host of other reasons," said Matt Weaver, a loan originator with CrossCountry Mortgage, based in Boca Raton, Floirda. "Not only were we having to balance helping borrowers trying to get their homes, but also regulations, licensing laws, continuing education, it was a challenging time in the marketplace for sure."
The recovery in home prices over the last four years has meant a corresponding easing in mortgage underwriting. The share of new mortgages with FICO credit scores less than 750 has climbed significantly in recent years, from just 41 percent of mortgages originated in 2009 to 53 percent as of 2017, according to a recent report from FICO.
But the mortgage market is nothing like it was during the heady days of the housing boom, when just about anyone could get a home loan with little to no documentation.
Today's borrowing is based on ability to repay. Income is far more important than any other factor, and lenders are opening their doors to new products for self-employed borrowers or those who don't fit exactly into the usual credit boxes.
All of this is why Congress and the Trump administration have done little to change the status quo. The housing market is not entirely recovered, as homebuilders lag demand, supply remains constrained and home prices overheat. Affordability is key, and mortgages are a major factor in affordability.
While most agree the status quo can't remain the status quo forever, no one wants to see a shock to the mortgage system and a reversal of this decade of repair.
"It's time to end the conservatorship. The problem is, there's no agreement on how to do that, and as a result we have the stalemate that continues," Seibert said.