How The Government Will Eliminate Fannie & Freddie (In One Simple Chart)

Tyler Durden's picture

On Sunday, Senate lawmakers unveiled the 442-page plan that will eliminate the mortgage-finance giants; replacing them with a new system in which the government would continue to play a potentially significant role insuring U.S. home loans. The Johnson-Crapo bill would, as WSJ reports, construct an elaborate new platform by which a number of private-sector entities, together with a privately held but federally regulated utility, would replace key roles long played by Fannie and Freddie.



Via WSJ,

Fannie and Freddie don't make loans, but instead buy them from lenders, package them into securities, and sell those bonds to investors. They guarantee to make investors whole if loans default, attracting a diverse range of investors to the U.S. mortgage market.




The Senate bill would repurpose the firms' existing regulator as a new "Federal Mortgage Insurance Corp." and charge the agency with approving new firms to pool loans into securities. Those firms could then purchase federal insurance to guarantee payments to investors in those bonds. The FMIC would insure mortgage bonds much the way the Federal Deposit Insurance Corp. provides bank-deposit insurance.


Mortgage guarantors would be required to maintain a 10% capital buffer against losses and to have that capital extinguished before the federal insurance would be triggered. Those private firms, which could include banks or insurance companies, would issue a single security through the government-regulated platform. Different components of Fannie and Freddie could be sold to seed both new guarantors and the mortgage-securitization platform.

Market impact:

Shares of the firms' common stock dropped sharply last Tuesday, when lawmakers announced that they had reached agreement on broad outlines of the bill. Still, several large investors have said that they're invested for the long haul, either because they believe Congress isn't likely to reach agreement or because they believe courts will invalidate the government's ability to seize all of the firms' profits as dividend payments.


If courts rule that the government overstepped its authority in revamping the bailout terms, Fannie and Freddie would be allowed to retain any profits after paying a 10% dividend to the government—currently around $12 billion annually for Fannie and $7 billion for Freddie. A court win would increase prospects for shareholders to enjoy returns in any liquidation of Fannie and Freddie because the companies would again be able to retain profits.

For now, it seems, the market believes the bill (or some form of it) will be enacted...


Still confused? Here is Acting-Man's Ramsey Su to explain it all (and destroy some hope)...

No Opportunity Necessary,  No Experience Needed

Freddie and Fannie are back in the limelight.  This time, the plan is coming from Senate Banking Committee leaders Tim Johnson (D., S.D) and Mike Crapo (R., Idaho).

Here are the bios of Johnson and Crapo, two lawyers with not a trace of experience in real estate finance and housing matters.  They represent Idaho (pop 1.6 million) and South Dakota (pop 0.8 million) with a combined population of about half a Phoenix (pop 4.3 million).  Neither State played any role in the subprime bubble.  Johnson/Crapo simply do not possess even the most basic qualifications for the job.

It is not my intention to belittle Johnson and Crapo but here are the circumstances.  At issue is the failure of the two mortgage giants that resulted in placing them under conservatorship for over five years so far.  On one side are all the lobbyists, trying their utmost to mold political decisions to their clients' best interest.  Hedge funds are salivating and suing the government to give them more money for reasons that I cannot understand.  On the other side of the table are these two Senators who are supposed to look out for the public good and somehow come up with a system that can replace the agencies.  Judging by their resumes, would you hire these two men to fix the agencies? Do you think they possess the knowledge and skills to comprehend the complexity of the mortgage industry and the secondary market for securitized products?


Inner Contradictions

Giving the Senators the benefit of the doubt, I read the proposed plan.  It is full of political jargon with objectives that are mutually exclusive.  On the one hand, they want to protect taxpayers but they also want to provide financing with downpayments as low as 3.5% while making sound loans at low cost only to qualified buyers using the CFPB qualified mortgage guidelines, blah blah blah ……..  For a second there, I thought Franklin Raines (long the mouth piece/CEO who took down Fannie) had returned.  


Protect taxpayers from bearing the cost of a housing downturn. 
• Promote stable, liquid, and efficient mortgage markets for single-family and multifamily housing. 
• Ensure that affordable, 30-year, fixed-rate, prepayable mortgages continue to be available, and that affordability remains an important consideration. 
• Provide equal access for lenders of all sizes to the secondary market. 
• Facilitate broad availability of mortgage credit for all eligible borrowers in all areas and for single family and multifamily housing types. 

What exactly are Freddie and Fannie today?

They are two duplicating agencies that package real estate mortgages under a set of underwriting guidelines.  These packages are resold on Wall Street as agency MBS (mortgage backed securities).  For a fee, the agencies guarantee these securities.  Since the agencies are under the conservatorship of the US Treasury, this guarantee is practically as good as any other Treasury debt.  


Are Freddie and Fannie profitable?

If you read the headlines, they are supposedly making money hand over fist.  They are returning hundreds of billions of "profits" to the Treasury.  But how can anyone determine what is "profit"?  The agencies are essentially insurance companies, collecting a premium to guarantee about $4.5 trillion of debt.  However, there are no insurance commissioners nor guidelines as to what they need to reserve against potential claims.  


Then what should be the amount of reserves?

Well, that is a question with no answer.  If you treat the agencies as insurance companies, which they are, then it is possible to calculate the needed reserves, bigger ones for the subprime and high LTV loans, smaller ones for low LTV and prime borrowers, etc.  However, how can an insurance company reserve for government intervention, especially the retroactive type?  For example, the administration is touting that about 2 million mortgages have been modified through various fixes under the Making Home Affordable Program.  Who paid for this?  Furthermore, the agencies are now holding these modified loans that actually do not meet present underwriting guidelines.  This is a high risk portfolio with high LTV and most likely subprime borrowers.  One hiccup in the economy and they will all return to the delinquency pool.  What if FHFA, under Mel Watt, decides to launch principal reduction programs, who will pay for those?


A Great Business Model

Back to the "profits", as long as real estate prices appreciate, default risk will remain low and the agencies are home free.  If real estate prices stall, or decline, then the agencies simply ask the Treasury to fund their losses.  What a great business model!  No wonder hedge funds who bought the agency stocks at bankrupt prices are clamoring for the return of these "profits".

The agencies have monopolized the mortgage market, commanding a 90% market share during the last few years.  The remaining 10% are going to jumbo loans and non-mainstream programs that have little effect on the overall market. 


Not Charging Enough

What should be the cost for the agencies to insure the mortgage industry?

Whatever the agencies are charging, they are not charging enough.  This is evidenced by the fact that no one in the private sector is willing to step up and compete.  There is not a single mortgage program that offers financing to the masses that is not agency conforming, not from the too-big-to-fail banks, not from the small regional banks.  Why bother when you can originate loans and collect fees, while letting let the agencies rubber stamp them with an iron clad guarantee backed by the US taxpayers. 


The Fed

Let us not forget the Federal Reserve.  Under QE3, the Feds purchased $788 billion of agency MBS last year and $105 billion so far this year ending March 8.  As of March 12, the Fed holds $1.57 trillion of agency MBS on its balance sheet.  

If the agencies are privatized, are the Feds still authorized to hold these loans on their balance sheet?  Can the Feds continue to purchase originations?  Would the Senators' plan neutralize the Fed and render one of its favorite manipulation tools useless?  How much higher would mortgage rates be if the Fed were out of the picture?

Chris Whalen provided an excellent analysis on Zero Hedge that may be a little too technical but it highlights some of the screw-ups that have led to the agencies' demise.  It is about to get worse.



In closing, I am attaching the "Details of the Agreement on Housing Finance Reform" below.  What I see is at least 2,000 pages of regulations, expecting a miracle fix that even Moses may have trouble performing.

Details of the Agreement on Housing Finance Reform 

Outlined below are some of the details of the agreement that Chairman Johnson and Ranking Member Crapo have reached that will form the basis of a bipartisan housing finance reform text: 

Start with S.1217 as the base text and generally maintain its overall architecture. 
Wind down and eliminate Fannie Mae and Freddie Mac. 
Promote a smooth and stable transition from the old system to the new system by providing specific benchmarks and timelines to guide Federal Mortgage Insurance Corporation (FMIC) and market participants. 
Transfer appropriate functions to the modernized, streamlined and accountable FMIC, modeled in part after the FDIC including its regulatory authority. 
Mandate 10 percent private capital, up front, and create a mortgage insurance fund for the system to protect taxpayers against future bailouts. 
Create a member-owned securitization platform that will issue a single, standardized FMIC-wrapped security, and permit private label securities to be issued in a manner that encourages standardization and improved market liquidity. 
Establish a mutual cooperative jointly owned by small lenders to ensure institutions of all sizes have direct access to the secondary market so community banks and credit unions are not at the mercy of their larger competitors when Fannie Mae and Freddie Mac are dissolved. The small lender mutual cooperative would provide a cash window for individual eligible loans, and small lenders could retain servicing rights. 
Provide clear rules of the road for servicers that choose to participate in the FMIC system. 
Maintain a vibrant multifamily market by building upon successful risk-sharing mechanisms and products and providing access to a broad range of markets. 
Require strong underwriting standards that mirror the definition of “qualified mortgage”, and set down payment requirement at 5 percent (with a short phase-in) except for first-time homebuyers at 3.5 percent. 
Facilitate the broad availability of credit for eligible single-family and multifamily borrowers, monitor consumer and market access to credit, and provide market based incentives and transparency to serve underserved areas. 
Eliminate affordable housing goals and establish transparent and accountable housing-related funds that would focus on ensuring there is sufficient decent housing available. The funds are NOT paid for with tax dollars, but through a small FMIC user fee (10 basis points) that only those who choose to use the system pay. 
Allow current conforming loan limits to be maintained so that mortgage credit continues to be available in high cost areas. 
Maintain broad liquidity in the To-Be-Announced (TBA) market and direct FMIC to take into account the impact of new products on the TBA market.

Addendum: The Bill Has Been Published

The bill discussed above can be accessed here (pdf, 442 pages)

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becky quick and her beautiful mouth's picture

all your houses are belong to us.

Vampyroteuthis infernalis's picture

With a name like Crapo what could go wrong?

Squid-puppets a-go-go's picture

more evidence that the financial weapons of mass destruction of 2009 are to be enshrined and elevated rather than scrapped and outlawed

Unknown User's picture

It’s worse, the taxpayers will insure their crap.


"Two Tens for a Five"


Hippocratic Oaf's picture

Here we go, all over again.

Just tell'em it's AAA...........why should they believe any different?

whoisjohngalt11's picture

Brought to You by crapo and friends/(Johnson-Crapo bill)

Son of Captain Nemo's picture

The Johnson-Crapo bill...

Does that losely translate into"Dick-Shit"?

Jonas Parker's picture

Nothing loose about the translation at all...

rqb1's picture

Yes.  There is no way this passes.  The judge has already ruled for discovery.  This is just a smoke screen for ws to pick up shares at lower prices. 


Sleepless Knight's picture

Everything the government touches turns to shit. Why would I expect anything different this time?

0b1knob's picture

"privately held but federally regulated utility"

Just like Fannie and Freddie?  Who would be stupid enough to buy it?  Oh well, pension funds still buy GM bonds.   They will never learn.

Stoploss's picture

What could possibly go wrong???

bpj's picture

more like were're going to cornhole you


bpj's picture

more like were're going to cornhole you


TheFreeLance's picture

You knew they'd try to re-inflate the meta-bubble sooner or later, likely in an off-year election cycle to maximize contribs. But this is just breathtaking.

Quantum Nucleonics's picture

That Fannie and Freddie continue to exist is purely an Enron-esque accounting gimmick.  If they were dissolved, all their debt would flow to the government's balance sheet.  That's exactly why Iceland and Ireland ended up needing bailouts.  Now that the government has clawed back its bailout cash, more or less, they can be wound down without anyone in government taking responsibility for anything that went wrong.  Anyone that bought Fannie or Freddie stock and thought the government wouldn't shank them at first opportunity deserves to lose every penny.

rqb1's picture

They wont shank the Carlyle group and they will lose in court. 

The Econ Ideal's picture


The continued gov't guarantee (even if it is "only" of the MBS sold to investors) does not eliminate moral hazard or TBTF. Get the gov't out of the mortgage markets. 


Rainman's picture

Too late now. Banksters won't lend mortgage money to low score muppets without a 100% Uncle Sugar backstop. The real money is made in the trading markets . No losses....and the outcomes are controlled.

JR's picture

IOW, the globalists that control America’s government can continue to put subprime buyers into US housing and the US taxpayers will be forced to guarantee the loans. IOW, wealth transfer from the middle class to the lower classes and the upper classes -- and more to come with DC plans for amnesty: bringing the total of Mexicans in America to 83 million.

GoldSilverWolf's picture

More likely to happen is the Putin-Jinping proposal.

buzzsaw99's picture

Let's see if I have this right. The agencies won't hold the mortgages anymore, the banks will. So the agencies have hardly any revenue coming in during good times but a HUGE potential insurance liability in the coming great depression 2? great plan, the bankers win again.

JR's picture

The American economy is going to collapse. The Fed’s objective is to save the banking system; not you.

John Williams Massive Dollar Selloff in 2014 Game Over | USA Watchdog Report (video) 

Published on Mar 10, 2014

“John Williams of has a grim view of 2014. He says, It's really going to be a currency panic . . . that the fundamental selling pressure is real.” He says there’s a 95% chance of hyperinflation in 2014, probably beginning in the first half of the year. It’s already baked into the cake…

KidHorn's picture

I don't see how this system is much different from the old system. Either way, the gov't will be stuck guaranteeing a lot of bad loans in order to keep housing prices propped up.

bh2's picture

The more it changes, the more it stays the same.

Pig Circus's picture

What the fuck ever. So the banks take the loss but we know that Dodd-Fag provide for bail-ins. So the saver who is currently getting screwed with .00000001% on his savings will soon get screwed again.

NOTaREALmerican's picture

As long as house prices are kept high I'm good with whatever Big-Gov scam they create.

pods's picture

And you say you are not a real amerikan.  

That is as amerikan as apple pie and drone delivered wedding presents.


yellowsub's picture

It's pretty much a repeat of the last crisis, those still putting down 3.5% would not be able to weather any type of down turn because their non existant savings.


NOTaREALmerican's picture

Crony Capitalism, actually.   But the results are the same.   Actually, there's no other system possible, it's the same one used everywhere on the planet.  The smart-n-savvy people make deals to screw the dumbasses.   What other system would exist?   The nice people don't get screwed?

johny2's picture

i would say exactly opposite is the case.

it is often less smart who get together and take away a produce of the smarter by force. It is possible that humans are species that instead of evolving, are de-evolving as shown by the fact that many monkeys seem less likely to be fooled by the same tricks repeated so many times.

Seer's picture

Fannie and Freddie take a Crapo...  Might need a rating of "X."

johny2's picture

United Socialistic States of America knows it has to keep the american citizens better of than than the rest, as they are well armed and serve well as the army personel needed for keeping the order where the resources are taken from. Free housing, drugs, fast food and smart phones for all! 


fzrkid's picture

who bails out the insurance entitiy when the new heavily capatilized firms claim loses on the mortgages they purchased

NOTaREALmerican's picture

Belgium.    Was covered two or three posts ago.

Seer's picture

... looks on his watch, tap, tap... "Where's that 777?"

i_call_you_my_base's picture

It's hard to see how something like this will play out, but you can guarantee it's got the right loopholes to inflate (reinflate, superinflate) a housing bubble.

Johnny Cocknballs's picture

To rephrase a bit:  banks created money out of thin air to loan to people who have to work for around 25-30 years to pay it back, with interest amounting to...roughly 3 times the actual value of the house at purchase. 

The government then takes taxpayer money, gives cash to the banks, then sells tranched CDOs or whatever other mbs derivative to... the same banks, who can use some of the cash they got from selling prior bundled notes to .gov to buy the derivatives.

Then if the banks get over-leveraged and/or otherwise fail, .gov will use taxpayer money to bail them out, socializing their losses while keeping their profits and bonuses both absurd and private.



NOTaREALmerican's picture

Gotta hand it to them smart-n-savvy people, they sure know how to scam the dumbasses.

Survival of the fittest, Bitchez!!!

BandGap's picture

Is it me or have 2200 pages of laws and regulations confused people before? Wait, that's the intent while they pick their fucking pockets.

Baffle them with bullshit, no, Johnson-Crapo.

slightlyskeptical's picture

Might as well just keep Fannie and Freddie intact, include the 10% thingee on all new mortgages and welcome new entrants as well.

This achieves nothing but moving profits out of Fannie and freddie and into private hands.

I also think that we need a national, government sponsored non-profit primary mortgage system. I think it atrocious that we allow investors, using other peoples money ultimately backed by the government, to take a huge piece of homeownership costs over time. Shelter is a basic human need and our governemnt should ensure we have access to it without fattening the wallets of several layers of middlemen. Banks/investors should be limited to origination and servicing and should not be allowed to have any interest in the ongoing mortgae payments.

I am all for allowing banks to make money on second mortgages, second properties and the such. Just not primary home ownership.

Seasmoke's picture

Sounds like privatize the profits and public the losses.....SSDD

DIgnified's picture

Home-bamacare or;  How I learned to stop worrying and love cardboard boxes



Sach Mahoney's picture

If you like your house, you can keep your house