On Aug. 6 President Obama gave a speech in which he addressed the future of the housing market in the U.S., specifically in the context concerning the future of the much-maligned Freddie Mac and Fannie Mae.
Currently these two mortgage behemoths provide backing for 90 percent of U.S. home loans. When you or I apply for a mortgage through our bank or broker the loan is eventually funded by one of these entities. Once the loan is funded our mortgage is likely securitized into a mortgage-backed security. The ultimate investor in the mortgage-backed security invests knowing that if you or I default on the mortgage payments, Freddie or Fannie ultimately will make the security whole and losses will be mitigated.
While Freddie and Fannie are not government agencies, they are what are called government sponsored agencies or GSE’s. While the mortgage backing provided by the GSE’s did not involve explicit taxpayer backing, they did have implicit backing which during the financial crisis the government did make good on by taking both Freddie and Fannie into government backed receivership. Despite the calamity that was largely caused by mortgage lending, no investor in Freddie or Fannie bonds or mortgage securities incurred a principal loss.
This now explicit government backing of nearly all home mortgages presents an enormous level of risk to the U.S. taxpayer, and it is prudent for the government to squeeze out this position by reforming this arrangement.
This was reflected in the president’s speech when he said, “I believe that while our housing system must have a limited government role, private lending should be the backbone of the housing market.”
So what does this really mean?
There are a number of bills currently working through Congress reforming mortgage lending. One with considerable support in the Senate would transfer some lending risk back to the banks funding the loans and require the bank itself provide 10 percent backing to any mortgage loan it makes. Another bill in the House provides for no assurance to mortgage investors by either banks or the GSEs.
Changes like this will certainly drive the interest rates on mortgages higher as private investors will have little incentive to fund an un-backed mortgage at the low interest rates we have all become used to. It is even likely the 30 year mortgage itself becomes a thing of the past, as this structure is not one likely to be embraced by private capital, either.
The home finance industry in the U.S. is unique in the world. I am aware of no other country in which the government provides backing for such a large part of the consumer economy. I will reserve judgment on this subject until we get some resolution, which will take years. All home owners, and potential home owners, should pay attention to this debate. If you haven’t attended to your mortgage lately, here is one more incentive to take another look.
Opinions are solely the writer's. F. Marc Ruiz is a local investment strategist and co-host of "Your Mind on Money" at noon Mondays on WLPR-FM 89.1 The Lakeshore. Reach him at firstname.lastname@example.org.