Secondary Changes

It may be a while before we know what reform of the government-sponsored enterprises means for mortgage servicers. But some of the broad outlines of what is likely to occur - if GSE reform is enacted - have taken shape. You can expect to see a regulator with stronger powers, for instance. The GSEs may find it more difficult to obtain authority to engage in new activities, especially if those activities infringe upon the origination of loans.

And, last but not least, the GSEs may find themselves operating under limits to how large they can grow their portfolios. In recent years, both Fannie Mae and Freddie Mac have made hefty profits by holding home loans in portfolio and issuing debt in the capital markets to finance those portfolios. In essence, they have been acting as giant thrifts.

While that portfolio business has helped make the GSEs more profitable than ever before (Fannie Mae's earnings doubled during the tenure of ousted CEO Franklin Raines), growth in the portfolios has heightened concern about the safety and soundness of the housing GSEs. That's because the long-term mortgage portfolios that serve as assets on the GSEs' books are largely financed using short-term debt, precisely the scenario that got the thrift industry in trouble starting back in the early 1980s.

The GSEs, of course, have substantial expertise in managing interest rate risk. Fannie Mae and Freddie Mac have recruited plenty of capital market veterans to manage interest rate risk exposure. But the complicated derivatives used to hedge interest rate risk have sometimes added to concern about the safety and soundness of the GSEs. Now we have concern about "counterparty" risk to take into account.

The GSEs say that their ability to purchase loans for portfolio contributes substantially to their housing finance mission. Today, commercial banks have a big appetite for home loans and originators aren't having any difficulty finding an exit strategy. But the GSEs say that they are reliable buyers of loans even when the rest of the market loses interest. That could be important to ensuring liquidity for the housing finance business. Whatever future vision of the GSEs emerges from the regulatory reform fight, we hope it won't impact servicers too much. But as with any debate in Washington, servicers should be keeping a close eye on this one.

Copyright 2005 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.mortgageservicingnews.com