In an effort to streamline and standardize how conventional mortgages are made and sold on the secondary market, the Federal Housing Finance Agency (FHFA) is proposing to marry the two giant mortgage entities.
This is quite a shift, since Fannie Mae and Freddie Mac have existed pretty much in their current form for as long as anyone in the mortgage industry can remember.
Fannie and Freddie, currently known as Government Sponsored Entities (GSEs) have operated as quasi-government corporations since 1968 and 1970 respectively. However, Fannie Mae was created long before, in 1938, and was privatized in 1968.
The purpose of these corporations is the provide the public with easier access to home financing options – meaning better mortgage programs and lower interest rates.
However, the companies came under scrutiny before and during the housing crash. Here’s why: they were private corporations, yet in essence they were protected financially by the US Federal government. In other words, they enjoyed immense profits, all the while knowing that the government could never let them fail 1.
Before 2008, it was unthinkable that these entities could in fact fail. But Fannie and Freddie did their share of risky lending, despite the current perception that they require high down payments and good credit scores. These standards are a relatively new development (or, at least old, and new again). The Fannie/Freddie of the mid-2000s did a ton of zero-down and low-credit-score loans.
It’s this lending that led to massive losses and the 2008 “conservatorship” in which both Fannie and Freddie were placed under control of the FHFA2, where they remain to this day.
And it’s under this umbrella that the FHFA wants to join both entities into one Common Securitization Platform (CSP). The goals of this “wedding,” according to FHFA, are to
- Standardize mortgage, servicing, and appraisal data methods.
- Establish consistent policies for handling delinquent loans.
- Create efficiency by standardizing processes in which lenders work with these entities.
So what does that mean to the home buyer or someone who wants to refinance?
Here’s how the planned changes may affect the typical consumer:
Standardizing Data. As far as the first goal, nothing should change for the consumer. All it’s saying is that after the loan closes, data on each loan will be stored in a standardized way.
Consistent Policies. This goal is aimed toward delinquent loans. So as long as you pay your mortgage, it should not affect you.
Standardizing Policies. Number three is the kicker for you, the consumer. Here’s an example of what this might mean. In some scenarios, Freddie Mac is more lenient than Fannie Mae. So if a loan officer knows that Fannie won’t approve a certain scenario, he will not use Desktop Underwriter®, Fannie Mae’s computerized underwriting system. Instead, he will use Loan Prospector® which is Freddie’s system. This situation is fairly common in the mortgage industry.
Under the new CSP model, both systems would likely be integrated into one. So, would the more lenient or the more restrictive guidelines be implemented into the new system?
Well, you could probably guess. According to Freddie Mac, “The new framework encourages more consistent quality control and protects us and the taxpayers from the credit risk of loans not underwritten to prescribed standards3.” Read that “more restrictive.”
However, both entities know the consequences of excessive credit tightening. Too much restriction, and borrowers don’t get loans. They can’t buy homes or refinance into lower payments. The economy suffers. So it would seem FHFA would go about the merger of Fannie and Freddie very, very carefully.
Still, the merger could create one major drawback by definition: lack of competition. As mentioned above, currently one GSE can be more lenient or have slightly different loan offerings than the other. In this way, the two GSEs spur each other on to innovation, filling in the gaps left out by the other.
This is the very reason Freddie Mac was created in 1970 – to create more competition. Now it would seem the industry is going back to the 1938-1970 model in which one mega-entity controls everything. Although creating efficiency could be one outcome, another could be a giant monopoly that ceases to innovate or be pushed to become better.
But the “Common Securitization Platform” model is not a question of “if,” but rather “when and how.” Both GSEs have a lot at stake, as does the FHFA, and the taxpayer, who would foot the bill if either GSE were to fail.
With a recovering housing market and lessons learned from the past (hopefully), the joining of these these mortgage giants could turn out to be a good thing, and we could all soon be waving “bye bye” to Fannie Mae and Freddie Mac.
1 Time
3 Freddie Mac
