Why shut down Fannie and Freddie now?

After Fannie and Freddie were put into conservatorship, the Treasury began buying senior preferred shares of stock in the two, thereby keeping them afloat and fueling the nation’s mortgage market for the foreseeable future.

During the next several years, as the housing market crashed and then began to eke its way back, Fannie and Freddie drew $188 billion from the Treasury. They were in turn forced to pay 10 percent stock dividends back. Then in 2012, the Treasury announced that that agreement would be replaced by a quarterly sweep of every dollar of profit that each institution earned in the future.

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The move was designed to, “help expedite the wind down of Fannie Mae and Freddie Mac, make sure that every dollar of earnings each firm generates is used to benefit taxpayers, and support the continued flow of mortgage credit during a responsible transition to a reformed housing finance market,” went the 2012 release.

By 2012, with the housing market rebounding and newly originated loans faring better than any in history, Fannie Mae and Freddie Mac began turning annual profits. By 2013, those profits were growing dynamically, and the two are now nearing the amount they originally drew from the Treasury, although the payments do not go to pay back the draw. The Treasury still owns the preferred stock. The money simply goes to the government.

Now, as individual investors in Fannie and Freddie stock cry foul, launching lawsuits against the government and demanding their share, lawmakers are under increased pressure to find a fitting end for the conservatorship and the entities. The question is whether or not to put a government backstop into the market yet again.

“The construct of a government-guaranteed, mortgage-backed security is absolutely going to be needed,” said David Stevens, CEO of the Mortgage Bankers Association. “You can’t have a functioning housing finance system where private capital just leaves it in the next recession. You need to have constant liquidity provided to the U.S. system, and that comes from the guaranteed mortgage-backed security.”

Confidence is key going forward, and investors are unlikely to pour money back into the mortgage market without a guarantee that in another catastrophic crash there won’t be some government backstop. One of the leading bipartisan proposals in Congress, introduced by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., does create an investor and borrower-funded backstop. It will make loans slightly more costly, but the government guarantee on mortgage-backed securities would be there.

“The biggest problem is that Congress wants supercheap mortgages and they want to eliminate taxpayer risk for the housing market, and that’s just a holy grail to get,” said Guggenheim’s Seiberg. “Anything less than 100 percent government backstop is going to raise questions about whether fixed income investors are really going to be there to pick up the slack and to buy those securities.”

Federal regulators are already trying to shrink the portfolios of Fannie Mae and Freddie Mac, even as Congress still debates their future. They have layered on heavy fees to lenders, which have actually made conforming loans (those backed by Fannie and Freddie) more costly than jumbo loans funded by banks. There is also a move to lower the loan limits on conforming loans, which would push banks and investors to take on more of the markets.

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Article source: http://www.cnbc.com/id/101018586

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