Eliminate Fannie & Freddie, or Follow Ginnie Mae Model?

When a company is losing money, management tries to change that by lowering costs or making more money: simple. Why should Freddie & Fannie be any different?

Since Fannie & Freddie were taken over, they have steadily increased guarantee fees and lessened the degree of cross subsidization in credit pricing. But industry observers suggest that even with these improvements the GSE’s current pricing for credit guarantees is less than one would likely observe in a purely private, competitive market.

Put another way, given today’s real estate markets and delinquency issues, it appears reasonable to assume that fully private firms operating with their own capital at risk would be more likely to give greater weight to more negative scenarios or model uncertainty than F&F do operating under the umbrella of conservatorship and government capital.

In addition, private firms would likely target a higher rate of return than the GSE’s, and the market would demand higher levels of capital.

Therefore, a logical next step in government ownership of Fannie and Freddie is to continue down the path already started of gradually increasing guarantee fee pricing to better reflect that which would be anticipated in a private, competitive market.

And if you think about it, jacking up the g-fees might actually help stabilize things.

One can model and make educated guesses about the price a purely competitive, private market would charge for a given set of mortgage credit characteristics presented by any given borrower, but we can’t know this with certainty.

For these reasons, many believe that a series of periodic, gradual price increases makes more sense than one or two larger price adjustments, and thus anticipate the F&F will continue the gradual process of increasing guarantee fees. This will not happen immediately but should be expected in 2012, with lots of warning (as has become standard).

And don’t look for lenders to keep this cost. It will certainly be passed on to the borrower.

But Fannie & Freddie aren’t the only ones in the news. Ginnie Mae has reported that its fiscal year net income for 2011 hit $1.2 billion—a record.

“Ginnie Mae has had a remarkable year; it’s our best yet,” said its president Ted Tozer. “Our financial performance this fiscal year-despite a mortgage market still in turmoil-is a testament to our well-functioning business model. Our business is simple, our approach to risk-taking is conservative, and our ability to finance government-insured mortgages is helping to keep the housing market afloat.”

Numbers indicate that Ginnie-backed loans financed nearly 60% of all home purchases in fiscal year 2011.

And in fact so far this year Ginnie Mae (that doesn’t buy mortgages but instead insures and packages mortgages backed by the FHA, VA, and other agencies, and is 100% explicitly backed by the U.S. government) has issued more mortgage bonds than Freddie Mac.

And as politicians and regulators fumble along, either trying to figure out what to do about Freddie & Fannie or not dealing with the issue at all, some groups say Ginnie Mae is an example of how the government could retain a role in the market without the kind of taxpayer risk posed by Fannie Mae and Freddie Mac.

Under the Ginnie model, the FHA and servicers are the first lines of defense when a loan defaults.

Ginnie pays investors only when a servicer fails – like Taylor, Bean and Whitaker which was servicing $26 billion in Ginnie Mae loans when it collapsed into bankruptcy in 2009. Ginnie has $600 million in loan-loss reserves and $16 billion in capital reserves.

And smaller servicers should be happy to know that as larger companies may not want to service as many loans, Ginnie is trying to woo smaller players into selling and servicing Ginnie Mae securities. Perhaps this will help speed up the Ginnie Mae application and approval process which in some cases takes years.