The U.S. Department of the Treasury and the Federal Housing Finance Agency’s January 2nd press release about adjustments to the US Treasury’s Preferred Stock Purchase Agreements (PSPAs) has ignited the discussion about ending GSE conservatorship.
Fannie Mae and Freddie Mac, collectively known as the GSEs (government-sponsored enterprises), have been under federal conservatorship since the 2008 financial crisis. The topic of GSE reform has been debated ever since, with little progress made administratively or legislatively. Additionally, legacy equity holders have pursued protracted legal action against the US Treasury regarding the takeover of the Agencies at the time of the crisis. A press release from the Treasury and Federal Housing Finance Agency (FHFA) just after the New Year has given fresh life to this debate. Anxiety amongst investors and others with an interest in the future of US housing finance has returned. We want to assure our clients and partners that we are keeping a close watch on this ever-evolving process. We do not expect any imminent, dramatic or radical change to the existing structure of the US Agency Mortgage-Backed Securities (MBS) market.
What’s changed?
The 2 January press release covered material changes to the PSPAs, which govern conservatorship. Changes included eliminating previous restrictions placed upon the GSEs, clarification of capital requirements, and an outline of a process for ending conservatorship. Provisions that constrained the GSEs’ acquisition of certain loan types were removed with the goal of making the GSEs nimbler and better able to expand home ownership and support affordable rental housing. The GSEs must also adhere to capital requirements set by the FHFA to maintain financial stability given their role in the housing market. Lastly, regarding conservatorship, the US Treasury must consent before conservatorship could be terminated, including a structured process to guide the termination with minimal to no market disruption. This would also require extensive financial and market impact analysis, as well as public comment periods and input from the Financial Stability Oversight Council. These would serve to extend and draw out the timeline of termination. If conservatorship were ever to be terminated, the overriding objective would be to ensure the entities are well capitalised to weather any future risks to the housing market, as well as ensuring continued efficient flow of credit to borrowers.
A new political dynamic?
Ending conservatorship and privatising the GSEs is a popular theme amongst some top Trump supporters and potential administration officials (who also happen to own stock in the GSEs). It is reasonable to assume that calls to end conservatorship will only grow louder over the next few months. The Treasury could potentially stand to take in more than USD 100 billion if they were to sell some of their stake in the GSEs. That said, this was not a policy that Trump campaigned on and should be correspondingly low on his list of goals early in his second term.
All potential paths toward privatisation are immediately complicated. Rushed attempts to capitalize on the US Treasury’s GSE ownership stakes to generate near-term, non-tax revenue could have far-reaching implications on bond markets and housing stability. Republicans only maintain a thin majority in the US Congress which will be a hurdle to making any legislative changes. Lastly, making material adjustments via administrative actions could lead to significant political and legal hurdles on an item that was not a priority. The administration will also want to avoid any appearance of favouritism towards equity holders (hedge funds) relative to taxpayers. The best plan for an eventual GSE exit from conservatorship would be best drawn cautiously, with a combination of thoughtful administrative action combined with bipartisan legislative support, limiting as much as possible any disruption to the housing finance market.
It is important to remember that prior to 2008, the Agencies were public corporations not owned by the government. The GSEs were always thought to have an implicit guarantee from the government which allowed them to fund cheaper than any other public company. The Agencies were forced to go into conservatorship because of their massively levered securities portfolios, not because of their mortgage guarantee business. No Agency MBS investor has taken a credit loss due to a delinquent borrower, prior to the crisis or since. Regardless of what the ownership structure is of the GSEs, they will continue to provide investors with that same comfort that their principal is guaranteed.
The GSEs are viable entities
The GSEs have a viable business model and can be brought out of conservatorship. According to the Congressional Budget Office, since 2008, the mortgage guarantee business has been profitable enough to allow for the GSEs to send materially more in dividends (USD 301 billion) to the government than they took in bailout capital (USD 191 billion) from the government. Since 2019, the GSEs have been able to retain capital. Fannie Mae has retained capital of USD 90 million and Freddie Mac has USD 56 million as of the end of the third quarter, 2024. Privatising the GSEs would not lead to wholesale changes in the way loans are made to homebuyers or those looking to refinance, nor how those loans are structured and sold to investors. The GSEs will continue to have a line of credit to Treasury that they can use in case of emergency, just as they did in 2008 and have now. They will continue to be highly regulated, and any portfolio activity will be subject to microscopic scrutiny. They will certainly not be permitted to engage in any kind of levered securities portfolio as they did prior to 2008. The portfolio will be utilised to support the flow of mortgage capital to borrowers, from investors.
In closing, while GSE reform is certainly a possibility in the future, our view is there is little to suggest any meaningful change happens in the near or medium term. This includes any impact to market function. The Agencies will continue to operate normally, facilitating the flow of credit to a highly efficient capital market.
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