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Why Not Make the GSEs More Like Ginnie—Or Like the Banks?

MAY 8, 2014 12:20pm ET
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With the Johnson-Crapo Senate bill seemingly stalled, legislators and regulators may want to start thinking about other solutions to reforming the government sponsored enterprises.

One possibility is to use Ginnie Mae, the least infamous of the three agency cousins, as a template to fix what's ailing Fannie Mae and Freddie Mac. A more provocative idea is to turn the agencies into commercial banks, similar to what was done for two Wall Street houses in the 2008 market collapse.

Alternative GSE fixes like these may not just be rhetorical exercises. Of the legislation before Congress, the House bill proposed by Rep. Jeb Hensarling, R-Texas, seems dead in the water and consideration of the Senate bill sponsored by Sen. Tim Johnson, D-S.D. and Sen. Mike Crapo, R-Idaho, has been delayed. Though neither of these ideas has a better chance than Johnson-Crapo, parts of them might be useful for an eventual hybrid fix that could muster enough votes.

John Dalton, a former Government National Mortgage Association president who is now chairman of the Financial Service Roundtable's Housing Policy Council, suggested the Ginnie Mae model at SourceMedia's recent Mortgage Servicing Conference in Dallas.

While endorsing Johnson-Crapo as the best fix with a chance of passing, Dalton said "Ginnie Mae has been a great program since 1968 and at no time has the government ever been called on to pay. I think the same thing can be structured in the conventional market so it too can be safe."

Ginnie Mae takes mortgages from the Federal Housing Administration and Department of Veterans Affairs, and to a lesser extent from the Department of Agriculture's Rural Housing Service, and packages them into securities for sale to investors. Ginnie Mae is an efficient and profitable agency of the government. Its issuer-servicers (banks, mortgage banks, thrifts, credit unions) underwrite the loans. FHA provides the mortgage insurance; Ginnie simply guarantees timely payment of principal and interest on the bonds, and oversees servicers to make sure they perform their duties. FHA and Ginnie Mae are units of the department of Housing and Urban Development.

A big plus for this plan: risk-averse investors like Ginnie Maes because of the "eagle" stamped on the notes: they are backed by the full faith and credit of the United States. A big minus: a huge increase in government mortgage insurance and the risk that entails. (Freddie and Fannie use private mortgage insurance for low down payment loans.)

Ginnie Mae is nothing if not efficient. It earned $625 million last year for the government, and had a total staff of fewer than 130, meaning each employee generated about $5 million in profits.

Fiscal 2013 was Ginnie Mae's best year to date, as FHA continued to pick up the slack from market share abandoned by the conventional agencies. GNMA guaranteed $460 billion in MBS last year, a record. However, FHA has been hard pressed to stay in the black and its mortgage insurance fund fell to a negative 1.44% in fiscal 2012, according to HUD, which projects it to return to the black in 2015. And Ginnie issuance has slowed this year in line with the general market, data from Mortgagestats.com shows.

Garth Graham, a partner at the consulting firm Stratmor in Fort Lauderdale and former head of e-commerce lending at ABN Amro Mortgage, has a few reservations about the Ginnie model. He says he likes the fact Fannie and Freddie were run as businesses (though he acknowledges that they ran their businesses off a cliff) and since they were profit-driven they developed a huge talent pool and many innovations in technology.

"Whatever they do, I hope they maintain that strong core of talent at the two agencies," he says.

Alex J. Pollock, a fellow at the American Enterprise Institute in Washington, says that an expanded Ginnie Mae would make some sense if Congress is going to put the eagle on Freddie's and Fannie's volume. But he has another model of GSE reform in mind.

Basically, he would turn Fannie and Freddie into big commercial banks, similar to how Morgan Stanley and Goldman Sachs converted to bank holding companies after the collapse of 2008.

Specifically, he would make explicit the GSEs' Too Big to Fail status and throw them in with all the other systemically important financial institutions the Federal Reserve regulates.

"What we need is a simple, clear, a-partisan act to immediately reduce the distortions, systemic risk, capital arbitrage, taxpayer exposure and utter dependence on the government, of Fannie and Freddie. We have already worked out with great efforts over the past several years how to address TBTF banks: just apply this to Fannie and Freddie," he writes in a blog on The Hill. (That's "a-partisan" as opposed to bipartisan.)

The first thing he'd do is to give the agencies "the same leverage capital requirement as every TBTF bank holding company, namely, minimum equity capital of 5% of total assets."

He would apply all consumer protection regulations to the new SIFIs, and remove any "special treatment" they receive in exemptions from banking regulations. Just as with all other TBTFs, they would no longer be exempt from state and local income taxes.

Pollock would also like to see Freddie and Fannie pay the Treasury a fee for the government guarantees on their liabilities, "just as TBTF banks have to pay deposit insurance premiums." On top of that, he'd assess them an offset fee of 0.17% of total liabilities.

Another possibility, one that has been talked about on this site is that the two agencies be merged as a first step while Congress dithers on the ultimate fix. There's already significant agreement on combining their two MBS platforms (Fannie's is by far the stronger), so why not the rest of them?

Sure, there would be pain for some workers as efficiencies of scale are executed, but taxpayer money would be saved. A leaner, meaner combo would work politically as an interim fix, and there no longer is a clear delineation between the two entities.

A generation ago, they were quite different, justifying having two separate agencies. Fannie Mae was operated as a giant thrift, borrowing short and lending long on portfolio products that became badly under water in the 1980s. Freddie Mac, on the other hand, kept little to nothing in portfolio and was basically a securities shop. Each of the two moved towards the other's models in the 1990s in attempts to diversify risk. Fannie ramped up its MBS operation, while Freddie began to portfolio loans in addition to continuing its MBS volume.

The big question legislators would have to resolve here is: are the agencies too big to merge in addition to too big to fail?

Mark Fogarty, Editor at Large atNational Mortgage News, writes analysis and commentary based on his 30 years covering the mortgage industry.

Comments (3)
Both of these ideas have great merit. It's painful to hear talk of "doing away with" Fannie Mae & Freddie Mac. That approach seems ignorant of the fact that, beyond their core business, both Fannie & Freddie have provided important LEADERSHIP to the market. Both have championed innovation, invested in process improvements, and developed talent that is recognized globally. I've done consulting with housing finance lenders & governments in about 40 other countries - and have often been intrigued to hear clients say they wanted something done "to a Fannie Mae standard." We have the most sophisticated housing finance system in the world - and the world holds it in high regard. Let's not miss the fact that what's best for the future of the U.S.' housing finance system is not just good financial conduits. That leadership, innovation, investment, and talent will also be important to maintain.
Posted by Larry W | Thursday, May 08 2014 at 1:45PM ET
Simply put, the banks cost more when they failed than F&F.

What need to be considered is a approach to bring F&F back to where they were supposed to be, market makers. F&F should give the guidelines and format for the sale of MBS, but only intervene to act as a market maker. Yes, there will be times when F&F both buy and sell securities to keep the flow of money and mortgages in order. In the event of another massive economic downturn F&F would exist to purchase mortgages until the markets return to normal.

If we did not have F&F in 2008-9 real estate values would have fallen to what ever cash could have paid. I question is there is enough physical cash in the system for banks to support the mortgage market independent of the GSE's and FHA.
Posted by brian B | Friday, May 09 2014 at 10:49AM ET
The Johnson-Crapo bill has provided good focus on the discussion of the GSE issues, but creates uncertainties with new marketing entities/systems with unknown viability. Both of these GSE's have worked for decades with proven systems.

Restrict F&F's work to plain 15 and 30 year fixed rates and protect them from political social engineering. Rather than combine back offices, split both F&F into four or five smaller units to create additional competition. Their current technological architecture is dated and the best innovation comes from competition, plus they can build additional human resources for better industry redundancy. Smaller originators need F&F to compete against TBTF banks.
Posted by Dave F | Friday, May 09 2014 at 6:45PM ET
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