A number of observers have speculated about how the prospective release of Fannie Mae and Freddie Mac from government conservatorship will impact the residential mortgage market and mortgage loan costs.
The good news is that the two GSEs will benefit dramatically from exiting government control, but that process is likely to take many years and will require a complete cultural and personnel makeover of both organizations.
In financial terms, there are three key issues to consider: credit ratings for each GSE, funding costs given those ratings, and most importantly, the cost of mortgage loan insurance over the next decade.
The GSEs are really in the business of insuring loans against default, including all of the cash expenses involved in loss mitigation. The GSEs reimburse the expenses of conventional correspondents, taking most of the risk onto their books.
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One big caveat, as Freedom Mortgage founder Stan Middleman describes in my 2024 biography of him,
Upon release, the US government will likely remain the majority shareholder of both GSEs. This is a positive factor given that many observers have been concerned about higher mortgage interest rates if the conservatorship ends. So long as the US Treasury remains the majority voting shareholder of the GSEs, the credit ratings on Fannie Mae and Freddie Mac will be stable.
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Stability in credit ratings is important, speaking as a former ratings analyst at Kroll Bond Ratings, because the conventional mortgage backed securities (MBS) issued by the GSEs are not rated and depend upon the credit rating of the issuer – not the collateral. The AA+ rating of the GSEs currently depends upon the credit support of the United States. If the US sells its stake in the GSEs below 50%, however, then both would be rated as private finance companies, not sovereigns as today.
The stability of the credit ratings of the GSEs is also important because it directly affects funding costs. So long as the GSE's funding costs are stable, then the amount of increase in mortgage rates for consumers will be minimal. But if both unsecured debt and the spreads over Treasury yields that the GSEs pay today for MBS rise, the profitability of Fannie and Freddie will decline.
Today, Ginnie Mae MBS trade much tighter to the Treasury yield curve than do MBS issued by the GSEs. The coupon rates on FHA/VA/USDA loans are often, but not always, lower than conventional loans, which are priced for risk using FICO scores and loan-to-value ratios as key factors. Loans in Ginnie Mae MBS are not priced for risk, making them far more attractive for low income borrowers.
The average guarantee fee charged by Fannie Mae last year was
If Congress does not reverse the 2011 mortgage tax and/or the funding costs of the GSEs rise after release, then Fannie Mae and Freddie Mac will be under pressure to raise their guarantee fee. This will increase the cost of conventional loans to consumers and will also put downward pressure on the profitability of conventional lenders and the GSEs themselves.
If the GSEs raise their g-fee to compensate for the mortgage tax and/or a funding cost increase post-release, then banks, insurers and REITs who buy 1-4 family loans for portfolio will be even more competitive in the secondary market. When a nonbank lender sells loans to JPMorgan or PIMCO, they may get a better price.
What happens to mortgage servicing rights if Fannie and Freddie are released?
One possible change that may occur if and when the GSEs are released is that both entities may be forced to enhance earnings by formally retaining their mortgage servicing rights, a decision that would be a big negative for the conventional loan market and the investor market for MSRs.
Today conventional lenders are allowed to retain the MSR at the point of sale of the mortgage note at no cost, effectively helping to improve the poor execution in the secondary market for conventional loans.
So if the GSEs are released and if the spreads on their debt rise over Treasury yields, then the management of the GSEs is going to either increase the g-fee and/or retain the full MSR of about 25bp on the unpaid principal amount of the loan. The GSEs will then pay their correspondents as sub-servicers.
If that happened, many conventional lenders could turn away from the GSEs and either issue private MBS or deal with the big banks and nonbanks led by JPMorgan and PIMCO. Imagine if the GSEs push their g-fees to 75bp, but "AA" rated JPMorgan can provide credit enhancement for half that amount. JPMorgan is the biggest private issuer of MBS, the biggest warehouse lender, and the largest owner of MSRs in the US,
According to the latest data available, the average cost to service a performing loan was $176 per year, the MBA found. So if a hypothetical $300,000 conventional loan generates $750 per year in gross servicing fees, the GSEs are currently leaving a lot of money on the table. Sellers of loans are allowed to retain the MSR for nothing, but that forgone consideration helps to compensate lenders for the poor execution in conventional loans.
What would happen in the event of widespread home price corrections?
The big issue regarding the release of the GSEs from conservatorship is credit and the prospect of a home price correction around 2028. At present, both GSEs are generating a lot of cash and have very low credit costs, although multifamily mortgages are a growing source of credit expenses.
If we see a significant downward correction in home prices, say minus 30-35% or down to 2020 levels, as Stan Middleman and many other industry observers have predicted, then the expenses of the GSEs are going to rise. Many of the loans written over the past five years will be underwater and the cost of credit, currently close to zero, will suddenly swing back to ~ 70% loss given default vs the UPB.
But the one thing that is very likely given a release of the GSE from conservatorship is that the market share for conventional loans, currently around half of the $13 trillion or so in total residential mortgage loans, will continue to shrink. Larger loans are being pushed out of the conventional market by inflation and will be underwritten privately by banks or nonbank investors.
Low-income borrowers under immense pressure in terms of affordability will find superior execution in the Ginnie Mae market. By law, Ginnie Mae only charges 6bp for the guaranty of a government MBS, but the loans are covered by other government agencies. By this time next year, Ginnie Mae will be 30% of all residential MBS and taking share from the GSEs.
