Could We Be On The Brink Of Another Housing Crisis?

Fannie And Freddie: Friend or foe? Some say a bit of each.

By Annette Barlow November 7, 2016
Copyright: Roman Bodnarchuk

Being granted tenure at Lehman Brothers; being gifted a Samsung Note 7; Stranger Things. Some things just seem too good to be true. Like Fannie Mae and Freddie Mac mortgages, the wildly popular and enormously profitable government-sponsored enterprises (GSEs) who, in the midst of the 2008 mortgage crisis, were extended a vast federal bail-out to prevent their inevitable black-hole-like collapse—and who, according to highly regarded financial officer Tom Forrester, are on the verge of meltdown once again.

Writing for the Washington Post, Forrester has outlined in alarmingly simple terms, the declining trajectory of these two GSEs—in spite of their seeming liquidity. These days, both Fannie and Freddie are profitable, and immensely so. In 2008, at the time both GSEs were put into government conservatorship by the Federal Housing Finance Authority (FHFA), both companies had positive net worth. In fact, the GSE model has outperformed all other real estate models for decades, its annual average loss paling in comparison to that of commercial banks—even during the housing collapse.

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So if these mortgage insurers are in fact so successful and profitable, why are they once again skidding down the slippery slope to self-destruction faster than Trump’s political integrity? Well, Forrester argues, it’s all down to a fundamentally flawed business model.

Back in 2008, 90 percent of the companies’ revenue came from risky investments involving borrowed money, and while Fannie and Freddie were turning great profits, there was a growing concern that their joint liquidity would not prove sufficient to handle the country’s increasing delinquency rates. Being unable to sell their debt, or even having to sell reduced amounts of debt at a higher cost, would mean the companies would not be able to weather expected future losses. Combined losses of $14.9 billion, and market concerns over the companies’ ability to raise and maintain capital threatened to disrupt an already weakened housing market. The scale of the loss, says Forrester, would be so great that insolvency would be the only future for the GSEs.

So, the government stepped in, pledging to invest $200 billion, and placed Freddie and Fannie in conservatorship, where their debt was handled while profits were syphoned off to the US Treasury. In 2012, the Treasury changed its agreement with the two GSEs, and began to take all their profits, the aim being to reduce both companies’ capital to zero by 2017.

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And, says Forrester, herein lies the problem. It won’t take another housing finance collapse to bring down Fannie and Freddie, he says. “All it would take is a modest increase in mortgage rates coupled with one quarter of less-than-optimal profits.” Which is pretty terrifying, if you consider that as of June 30, 2016, Fannie and Freddie own a combined $400 billion of mortgages, in addition to a guaranteed $4 trillion of mortgages—more than 40 percent of the total residential mortgages in the USA.

Stripping the two companies of their profits and capital “poses a huge risk”, warns Forrester. While today, Freddie and Fannie’s revenue comes from guarantee fees, which are both reliable and stable, they are both still susceptible to the effects of changing mortgage rates, and once again their ability to weather the storm is being called into question.

Forrester argues that when mortgage rates rise, the drop in value of Freddie and Fannie’s mortgage holdings could far exceed their operating costs for any given quarter, which will create an overall paper loss. Under their federal agreement, both GSEs would be required to borrow money to cover this loss. A standard loan, right? They’ve done it before—what’s different this time?

Well, in a nutshell, this time Fannie and Freddie will have no capital, and this will be a deterrent to the markets. What once seemed like an unlimited olive branch from the government will reveal itself to have a firm end date, and investors will likely get spooked by both companies’ lack of independent liquidity. Should these investors flee, no doubt Congress will once again be asked to step in and protect the GSEs from floundering and destroying the housing market. But, according to Forrester, this could do more harm than good: “The irony will be that without any help from Congress, the companies have already been reformed and de-risked.”

Instead, he advocates that Congress do two things to avoid the inevitable collapse of these institutions: firstly, the government should allow each GSE to keep $3 billion in capital deposits, and make profit sweeps to the Treasury annually rather than quarterly. This will stop a difficult quarter from generating a paper loss. Secondly, the government should establish a path to end conservatorship for both companies.

After all, the 2008 plan that was put into effect has worked. And like Forrester advocates, perhaps it’s time to “quit while we’re ahead.”


Annette Barlow



Annette is freelance editor, sub-editor, journalist and proofreader with a fierce love of all things feminist, food and music. She is a regular fixture on the arts, culture and feature desks at The Guardian, and her words have appeared on NME, Great British Chefs, The Fly, The Line of Best Fit and Australian Times.

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