Commentary
Commentary
October 2013
March 2014
Winding Down Fannie and Freddie—What Impacts Could It Have?
Recent draft legislation from the Senate Banking Committee proposes winding down Fannie Mae and Freddie Mac.
This proposal is just one of many trial balloons in the legislation, and actual reform is likely to take some time.
We believe the ultimate effects of reform will be fairly marginal, with little if any impact on our strategies.
Recently, the Senate Banking Committee released draft
legislation designed to reform housing finance in the U.S.
It contained numerous proposals, including one that
caught the eye of many investors—the winding down of
government-sponsored enterprises Fannie Mae (the
Federal National Mortgage Association) and Freddie Mac
(the Federal Home Loan Mortgage Corporation).
How Did We Get Here?
Fannie and Freddie, referred to as government-sponsored
enterprises or GSEs, were founded in 1938 and 1970,
respectively. Their shared purpose is to support the
country’s mortgage market by securitizing home loans into
mortgage-backed securities. This activity is how they fulfill
the mandate in their congressional charters to act as
reliable sources of liquidity and funding for housing finance
and community investment.
In 2008 at the height of the mortgage crisis, the two
companies became insolvent. As a result, the Federal
Housing Finance Agency (FHFA), under the auspices of
the Treasury Department, became conservator of Fannie
and Freddie. Treasury also invested in preferred stock
issued by the companies (at a stated yield of 10%) and
assumed control of the vast majority of their common
equity. In all, the federal government stepped in with
nearly $200 billion to guarantee several trillion dollars’
worth of obligations.
situation would have been unimaginable during the long
stretch of time when the housing-finance market was
reasonably healthy. Policymakers are now trying to
determine how to navigate a return to normalcy.
What Are The Implications?
At this point, there is simply no way to know what GSE
reform will ultimately look like, much less determine the
specific impacts it will have. It’s important to realize that
the proposals on the table are still works in progress,
subject to the influence of policymakers, the mortgage
industry and other stakeholders. The housing market is still
recovering from the 2007-2009 meltdown, and while we
believe reform is inevitable, we expect politicians to tread
cautiously lest they derail the healing process.
It’s also important to realize that an “unwind” of Fannie and
Freddie does not mean that the government intends to exit
the mortgage market entirely. We believe the vast majority
of politicians still see a role for the federal government in
housing finance. As a result, stakeholders are likely to
continue working toward a solution that will bring private
capital back into the market while maintaining a
reasonable government backstop. Furthermore, this
process is likely to take some time. The Banking
Committee proposed a five-year timeframe, and the
campaign season for midterm elections begins shortly. For
these reasons, we do not expect GSE reform to have a
significant impact on investors in the short-to-intermediate
term.
A Tangled Web Was Woven
Our Strategies
Thanks to a gradual recovery in home prices and the
broader economy, Fannie and Freddie have become
profitable again. As a result Treasury and, by extension,
U.S. taxpayers have enjoyed very healthy returns on these
investments. Taxpayer returns were further enhanced
when, in 2012, Treasury and FHFA executed a “net worth
sweep” that directed all of Fannie’s and Freddie’s profits to
Treasury. In response, junior preferred stockholders and
minority common shareholders have filed multiple classaction lawsuits against the federal government. This
© 2014 SEI
Within fixed income, we do not expect reform legislation to
negatively impact existing agency mortgage securities. In
fact, depending on how Fannie and Freddie are ultimately
unwound, it could prove positive at the margin. We expect
that any reforms will seek to ensure sound functioning of
the secondary mortgage market. In equities, while there
could be interesting sector and industry effects at the
margin, we do not expect GSE reform to impact our
strategies in a meaningful way.
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