F annie Mae and Freddie Mac are in play and with them the financial heart of the real estate marketplace. As they evolve – if they evolve – transactions worth trillions of dollars are at stake as well as billions of dollars in poten- tial profits. The battle for Fannie Mae and Freddie Mac – so-called govern- ment-sponsored enterprises or GSEs – involves two hugely prof- itable companies and what will become of them. They were open and functioning even during the worst moments of the mortgage meltdown. And yet, somehow, they are still in government hands after more than a decade as a federal conservatorship. The trillion-dollar question is what’s next for Fannie Mae, Freddie Mac, and the mort- gage marketplace? The Government Accountability Office has identified at least 14 GSE reform plans introduced on Capi- tol Hill to revamp Fannie Mae and Freddie Mac, plans announced pri- GSE Reform: Housing Finance Savior or Looming Disaster? BY PETER G. MILLER, STAFF WRITER

or to this year. Now there’s a 15th, a February proposal announced by Sen. Mike Crapo (R-ID), chairman of the Senate Banking Committee. After 14 times at bat, will the 15th congressional reform plan find enough support for enactment? Might the country adopt a proposal from the Ex- ecutive Branch or maybe a plan from outside Washington? Or – just maybe – will Fannie Mae and Freddie Mac con- tinue as they are, cash cows controlled by the government that mean billions of dollars in additional revenues for the Treasury Department? THE SECONDARYMARKET Fannie Mae and Freddie Mac now dominate the secondary market, the electronic arena where lend- ers and investors buy and sell mortgage loans. The GSEs buy mortgages from loan originators, package them together to create mortgage-backed securities (MBS), guarantee them, and then raise money through sales to investors. The secondary mortgage system offers several big benefits. First, it brings vast amounts of capital into the mortgage mar- ketplace. Not just cash from US investors but cash from sources worldwide. More cash (supply) means lower mortgage rates. Second, because of the secondary market, lenders never run out of funds. If a lender has $50 million set aside for mortgage lending, and if the typical loan amount is $200,000, the lender has the capacity to origi- nate 250 mortgages. Borrower #251 – no matter how well qualified – is out of luck because the lender has no more money to lend. Alternative- ly, through the secondary market, the lender sells its mortgages, takes in new cash, and then has the ability to make additional loans. Mortgage-backed securities,

according to the Financial Industry Regulatory Authority (FINRA), “are bonds secured by home and other real estate loans. They are creat- ed when a number of these loans, usually with similar characteristics, are pooled together. For instance, a bank offering home mortgages might round up $10 million worth of such mortgages. That pool is then sold to a federal government agency like Ginnie Mae or a govern- ment-sponsored enterprise (GSE) such as Fannie Mae or Freddie Mac, or to a securities firm to be used as the collateral for the new MBS.” So far, it might seem as though MBSs are being created and sold back and forth just like other bonds but that’s hardly the case. Mort- gage-backed securities are very differ- ent from the typical bond – and they’re also at the heart of the GSE debate. PREPAYMENT PENALTIES With the typical bond we have an amount borrowed and annual or semi-annual interest payments. The principal is returned when the bond matures. With MBS the fea- tures are entirely different. Instead of interest-only payments, investors with pass-through MBS receive a monthly return which in- cludes both interest and principal. The monthly payment may vary up or down depending on borrow- er performance. For instance, if a mortgage is refinanced, both the principal and interest payments for that loan go away. If interest levels for adjustable-rate mortgages (ARMs) go up, then MBS investors can see bigger monthly payments. “Prepayment risk, the hallmark characteristic of MBS, results from homeowners’ option to prepay their mortgage loans when it becomes advantageous to do so,” according to the Vanguard Group, manager

4 think realty housing news report

april 2019 5

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