The Future of Fannie and Freddie

Yesterday there was talk on the hill about the fate of Fannie Mae and Freddie Mac. Some believe these are outdated entities much to blame for the current state of affairs, and arguing for their continuation is to encourage a failing body. Others insist without them, the housing market and secondary would suffer even more and believe without them, lending would not be possible as it is; therefore those looking to buy or refinance would not be able to, essentially financing channels open right now would be closed without Fannie and Freddie. This whiplash would again jeopardize the fragile housing market which would put the overall economy in peril. Tim Geithner yesterday admitted that these two bodies needed a drastic overhaul, but he unfortunately did not go into any real detail as to what type of overhaul that may be.

Point in fact, Fannie and Freddie are currently major powerhouses behind lending. But when all is said and done, these two really do nothing more than write universal guidelines for everyone to follow, and package the loans that are closed under these agency guidelines together so they can then be sold to private investors, hedge funds, insurance companies, whomever. It is during this sale that Fannie and Freddie make their profit, taking what's known as a haircut off the loan. That is scraping some of the long term investor profit by charging the investor a premium up front for control of the note that will be paying over 30 years. Investors pay this premium because they understand that collecting the monthly payments will eventually yield them a larger return than the initial cost of the premium.

So what do Fannie and Freddie do? As far as I can tell, they write guidelines for everyone to follow, and they bundle loans together to sell to private investors after collecting a small profit. Now who is Fannie and Freddie? Well as of 2008 Fannie and Freddie are government run entities.... remember the federal government seizing Fannie Mae and Freddie Mac not too long ago because they were going to fail and ruin our economy. Anyway, essentially what this means is the government is now writing the guielines that allow you, me, or anyone to get into financing for a home. Since Fannie and Freddie attribute for about 8 out of 10 loans in the market they cater to a significant piece of the population. In addition to the government defining the requirements to secure financing in this market, they are also able to profit from the mortgage industry through the haircuts mentioned above... after all Fannie and Freddie both look to make a profit on the sale of these bundled mortgage notes.

So right now the government essentially writes the financing guidelines, profits on sale of your mortgage note in secondary, and collects property taxes on your home, and taxes on the profits the investors make holding the mortgage notes they just sold them. Considering this, I definitely think Fanne and Freddie need an overhaul. As they stand now, they are simply a vehicle for government control, and profit. If we were to dissolve Fanne and Freddie, investors could write their own guidelines (more competition), and would not be forced to pay haircuts (better terms). Essentially you would be unshackling the free market by dissolving Fannie and Freddie. As for too big to fail... spare me, the free market is too big to fail, every company operating inside of it is simply a cog that will be replaced with a more efficient cog when the first fails... that is productivity, and innovation. Why stifle it?

Yes I think there would be a couple months of unrest but in the end, the market shaping itself is much safer than an elected official trying to shape it for us... let's be honest they can't make sense of ANYTHING let alone a market none of them have any experience in.

It is my hope that Fannie and Freddie are dismantled. Remove them from the equation, let investors write their own guidelines, and let the chips fall where they may. I am confident that our market will not only survive it will flourish without these two entities. Do I think it will happen? No. I think whatever overhaul occurs to Fannie and Freddie will result in stiffer government controls which will create an even larger burden on the real estate finance market until they have systematically removed all the small players and they have a large beaurocracy in place and in charge of all lending in our Country. Their answer seems to be less competition not more competition, which is interesting because the immediate question becomes, well than how do you keep the cost down? The simple answer is you don't, why would they want to keep the cost down, they are in line to make a profit.