COVER STORY, MARCH 2011

THE FUTURE OF FANNIE/FREDDIE?
A recently released white paper advocating the end of Fannie Mae and Freddie Mac has the multifamily lending sector buzzing.
Coleman Wood

One hundred and thirty billion dollars.

That is the amount the federal government has spent to date rescuing agency lenders Fannie Mae and Freddie Mac. Much like their private-sector counterparts, the government-sponsored entities took big risks in the residential lending market in the run-up to the real estate bust in 2008 and paid dearly for it.

Now, the Obama Administration has released a white paper proposing to wind down both agency lenders. In “Reforming America’s Housing Finance Market”, the Obama Administration calls for legislation that would lead to the gradual exit of both lenders from the financial market.

The report outlines four steps to reducing the market share of the agency lenders, which, when combined with the Federal Housing Administration (FHA) and Ginnie Mae, currently account for more than 90 percent of new mortgages issued today. The steps include increasing guarantee fees to reduce the capital advantages the agency lenders had over private lenders, requiring larger down payments for mortgages, letting the temporary increase in conforming loan limits expire this October, and reducing the investment portfolios of the two lenders at the rate of no less than 10 percent per year.

Following the release of the white paper, the FHA increased its annual mortgage insurance premium by a quarter of a percentage point for all of its 15- and 30-year loans. The change will contribute approximately $3 billion annually to its Mutual Mortgage Insurance fund, which had capital reserves of approximately $3.6 billion at the end of the 2010 fiscal year.

The report says that future government lending should be reduced to select groups of Americans including the FHA loan program and current lending services provided by the Department of Housing and Urban Development, the Department of Agriculture and the Department of Veterans Affairs.

It goes on to outline three options for the future role of the government in residential mortgage lending. The first is for the government to only provide financing for the groups mentioned above. The second is similar to the first proposal but includes a guarantee mechanism that would serve as a way to ensure credit could be accessed by consumers during a time of crisis. The mechanism would maintain a minimal presence during normal market conditions. The final option would include the first option but the government would also provide catastrophic reinsurance for the securities of a select range of mortgages as a way to hedge them against another economic crisis.

This will ultimately affect the commercial multifamily sector by taking out one of the largest lenders in the game. However, the proposal includes several ways to lure private lenders back into the market to fill in the gaps.

The proposal also stipulates that providing more affordable rental housing should be a priority to any future government efforts. Several options to achieve this goal are mentioned including expanding FHA’s capacity to support multifamily lending and risk sharing with private lenders. However, the white paper is short on details for what the future of multifamily lending should look like.

“The fact that multifamily is mentioned in the second sentence of the second paragraph says to me that it is top of mind and a very important component of U.S. housing policy,” says Willy Walker, the head of Walker & Dunlop.

To Walker, the government’s complete exit from the lending sector would be unthinkable. He says the consequences of a fully privatized system would be the end of the 30-year, fixed-rate mortgage, as private lenders shifted all of the risk onto consumers. Loans would be impossible to come by for anyone other that the highest credit borrowers. This would have the consequence of pushing many former homeowners with lower credit scores into the rental sector — as much as 20 percent of single-family homeowners. Walker adds that this would go against the government’s position of giving people options when it comes to living arrangements.

“It’s more on the single-family side than it is on the commercial side…but if you think about the capital that will be required to step in and replace Fannie and Freddie, I put a big questions mark about how much capital there is for commercial real estate, given the amount of refinancings that are coming up over the next decade and the difficulties people are going to have rolling over that debt,” Walker says.

Walker sees the most likely outcome of the debate being that Fannie and Freddie’s multifamily lending platforms will be rolled into the FHA loan program and rebranded. He also predicts some kind of mortgage insurance backstopped by the federal government that private lenders can purchase.

Others agree with Walker. The National Multi Housing Council released a statement following the release of the white paper that reades, in part, “We encourage lawmakers to focus their attention — at least in terms of serving the rental housing industry — on the third option identified in the Obama plan, which would provide a federal guarantee at all times.”

The statement goes on to read, “The liquidity needs [of the multifamily sector] extend beyond the targeted affordable housing the Obama Administration plan identifies. It is the lifeline of the “middle market,” which the Obama plan agrees reform should continue to fund. Without a federally backed secondary market for multifamily mortgages, the apartment industry will not be able to meet the growing demand for rental housing. Between 2008 and 2015, nearly two-thirds of new households formed will be renters — that is 6 million new renter households.”

Many industry and political insiders believe it will take several years for any legislation overhauling Fannie Mae and Freddie Mac to get passed. The housing sector takes up approximately 20 percent of the country’s gross domestic product, and any legislation to wind down one of the largest players in the game will be thoroughly debated.

“I think as the debate unfolds people will start to realize the devil is in the details, and that some of the suggestions that have been advanced…have problems of their own and have been tried in the past in some way, shape or form,” says Grace Huebscher, president and CEO of Beech Street Capital.

Huebscher thought it a smart idea to make the proposal now, which she believes plants a stake in the ground for the issue. It also removes the ability of either side of the congressional aisle from using it as a campaign issue, as ending the agency lenders is popular with Democrats and Republicans.

She believes that the three options proposed in the white paper may not be the best course of action, pointing to a past in which the federal government was largely absent from the multifamily lending sector. The sector was volatile and sporadically liquid, given to following the latest trends, and the emergence of Fannie and Freddie as major players provided needed stability.

She senses that both agencies may turn around and could be profitable by the time debate over ending them begins. This could lead to the rise of a fourth option: keeping the lenders around, albeit with some reforms.

“I think reforming Fannie and Freddie and keeping them separate in their current form is probably the best for the country and may be a better way to get the country paid back faster,” Huebscher says.

Huebscher thinks there is a good chance the multifamily lending sector could stand a chance of being privatized, but she is wary of that route.

“I would caution that multifamily is the only part during this crisis that has functioned well and performed well under the GSE format,” she says. “It has been profitable, and it has had minimum losses. So, spinning off the most successful piece, which [itself] is a good diversification against single-family housing — I don’t know how much sense that makes.”

Walker agrees that more care should be paid to how Fannie and Freddie worked prior to the crisis, and that they should not be dissolved simply because it is a politically advantageous move right now.

“What is in Fannie and Freddie is really valuable, and there seems to be this push to say that we have to do away with them and be done with it,” Walker says, adding, “Before they go and dismantle these things, they really need to make sure they’re not throwing the baby out with the bathwater, because what I read in that white paper is that they’re contemplating doing just that.”

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