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Freddie, Fannie and Guantanamo Bay

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Freddie & Fannie Reform: President Obama said he would close Guantanamo Bay as soon as he became President. Now, the White House put out a plan to reform Freddie and Reform. I am wondering which will close first, Guantanamo Bay or the GSE's.

Nearly three years after the credit freeze of 2008 and the subsequent deterioration of the US housing market, the Department of the Treasury and Department of Housing and Urban Development have released a report to Congress on how TO reform THE US housing finance market. The thirty-two page document, which is thick on promises but thin on details, presents three options for reform – all of which include the winding down of the role of Government Sponsored Entities, Freddie and Fannie, in mortgage financing to be replaced with private market financing.

A thumbnail sketch of the three options offered in the report is as follows:
Option 1: No government role to support mortgage lending, except for limited programs from the VA and FHA.
Option 2: Same as Option one except the government would also provide mortgage guarantees when the housing market is in crisis.
Option 3: --The government would guarantee mortgages to low- and moderate-income borrowers, create a government reinsurance fund for mortgage-backed securities to respond to a housing crisis and would offer reinsurance for securities of some mortgages for a fee.

The goal of all three plans is the replacement of the GSEs with private sector financing – a long held dream of conservative pundits like Larry Kudlow from CNBC. With the release of this report, the political punching bags Freddie and Fannie received their final death sentence. AS WITH most inmates on death row, however the actual execution will BE DELAYED longer then ONLOOKERS expect.

By most estimates the implementation of any one of these programs will take five to seven years. My estimate is that it will take more like 10-15 years before Freddie and Fannie's role is significantly diminished in mortgage lending.

The main reason why one of these options won't be implemented sooner is that we are still in a declining market and private financing will likely be reluctant to risk large amounts of capital without government guarantees against losses. With little or no government support, when private financing is available it will be at higher interest rates and higher up-front fees for home buyers.

These costs in turn will exert a downward pressure on homes prices, possibly leading to more defaults. More defaults in turn will result in less confidence in the market and further declines in prices. If the country undergoes another recession in the next 2-3 years, with another wave of foreclosures and price declines, then private sector financing will be even more scarce.

While future homeowners will surely bare the financial brunt of these changes, there will be financial winners due to these changes as well. The major banks, mortgage insurers AND asset managers will be able to charge higher interest rates and fees when their major source of competition, the GSEs ARE removed from the market. Smaller banks, on the other hand, will no longer be able to sell their loans to the GSEs and will, therefore, join the future homeowners on the losers list.

When this story ends, the OUTCOME should be very interesting. I think back to how we were supposed to end THE ERA OF ALLOWING BANKS TO BECOME "TOO BIG TO FAIL." I wonder how big the banks will be in 10-15 years from now.

Logan Mohtashami is a senior loan officer in his family run Mortgage Company, AMC Lending Group, which has been providing mortgage services for California residents since 1987. LoganMohtashami.com

 

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