After seemingly endless partisan to-and-fro on who did what to whom on Fannie and Freddie, the Obama Administration today released its reform plan. The white paper essentially puts Fannie and Freddie into run-off – that is, a series of steps that shrinks them down and lets private capital back into the market. This isn’t strangling Fannie and Freddie now, as critics demanded, but it would surely lead to inexorable asphyxiation if the Administration acts on its proposals. As the garrote grows tighter, parts of the private market will spring to life.

This asphyxiation comes through a series of changes to GSE and FHA pricing and policies. Among the most interesting of these is a demand that the GSEs’ guarantee fees (g-fees) be repriced to reflect the costs a private securitizer would assume under the bank capital rules for holding risk comparable to that taken by Fannie or Freddie when they back an MBS. This is a powerful way to choke the GSEs by indirect application of robust capital rules – indirect application since redoing the GSEs actual capital requirements now would only put the conservatorships more deeply in the hole at still greater taxpayer expense. Pricing for capital doesn’t demand a capital infusion that, for now, can only come from Treasury, but it forces Fannie and Freddie to reflect the real risk they take.

Of course, stifling Fannie and Freddie in theory could leave FHA the big winner. We’ve long been perplexed by the plans of GSE privatizers, who think that throttling Fannie and Freddie will lead to a renaissance of private capital. This ignores the formidable role of the Federal Housing Administration. It’s a full federal brand of mortgage insurance for low-downpayment mortgages that funnels into the secondary market through full-faith-and-credit Ginnie Mae-backed MBS. Without reform also for FHA, any changes to Fannie and Freddie would be for naught. Indeed, they would only increase taxpayer risk.

As a result, the Administration takes on not just Fannie and Freddie, but also FHA. It rightly proposes not just pricing changes for the g-fees, but also to FHA premiums. As with much else in the white paper, this can be done under current law, meaning that U.S. mortgage finance can start to restructure itself as soon as the Administration acts on its proposals.

If these policies are quickly put into place in a clear, certain form, private securitization will start up again. Not fast and, God willing, not furious as in days gone by, but start it will. If the GSE and FHA pricing resembles private pricing for paper the private sector can back, private origination and securitization will have a prayer. Private mortgage insurance can also come out of the shadow in which FHA’s pricing and recent GSE policies have put it, with the Administration making clear that it wants this type of private capital in a first-loss position now for Fannie and Freddie and, then, in whatever successors take over government-backed securitization down the road.

Does this answer all the questions about what to do with Fannie and Freddie? Of course not. On this front, much to and fro is yet to come on the big-picture reforms also outlined in the Administration’s white paper. But, from a strategic perspective, the immediate question in mortgage finance is whether and how the Administration, FHFA and FHA will act on the near-term rewrite detailed in the reform plan. Even a few small cracks in the federal fortress could lead to significant new opportunities for private capital in this critical field.

 

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