Posted by Michael S. Canter (pictured) and Matthew D. Bass of AllianceBernstein (NYSE: AB)
A recent US Senate bill calls for a restructuring of the government’s role in housing finance, including winding down Fannie Mae and Freddie Mac. Here are five takeaways from the current proposal.
1) A new regulator would be created. As part of the overhaul, government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac would be wound down within five years. A new entity, the Federal Mortgage Insurance Corporation (FMIC), would be created to regulate the mortgage market. The FMIC would approve and oversee the packaging of securities by newly formed guarantors, but also guarantee these securities, backed by the full faith and credit of the US government. The guarantors, backed by private capital, would assume at least the first 10% of losses on the pools of mortgages they guaranteed.
2) Private firms will have to take on more risk, but that’s not necessarily a bad thing. The 10% requirement has been a sore point for many who think it’s too high. Some are concerned that this could lead to an undue increase in consumer mortgage rates, but we don’t believe this will be the case. We expect that the guarantors will be able to enter into risk-sharing transactions (similar to Freddie’s Structured Agency Credit Risk, or STACR, bonds) in which some of the risk will be rated AAA. This will make funding this risk capital efficient, and have a less dramatic effect on borrowing rates than some fear.
3) Potential opportunities exist for private capital. A new housing law could eventually translate into significant opportunities for private capital as GSEs (Fannie Mae, Freddie Mac and Ginnie Mae) begin to lower their market share from today’s 90% to 50% or lower. The bill lays out a combination of private capital from guarantors and capital markets via risk-sharing transactions. This system will create very attractive opportunities in mortgage credit.
4) Existing Fannie and Freddie obligations will have a US guarantee. All previous Fannie and Freddie debentures and mortgage-backed securities will be backed by the full faith and credit of US government. Investors will also choose to exchange their existing bonds for newly created FMIC-backed securities. We don’t anticipate any changes or challenges to the language related to this particular stipulation.
5) The probability of the proposal becoming law soon is very low. We think the current reform legislation—the Johnson-Crapo Bill—will make it out of the Senate Banking Committee. But some Democrats fear that the legislation (as currently written) could disrupt the US housing recovery. In the House of Representatives, many Republicans don’t want the government involved at all, and are unlikely to budge from this position before the upcoming elections, in our view.
We’ve been advocating for reform of the housing market for some time, and while the final legislation may still be a ways off, we’re encouraged by the potential it may have for the mortgage market. We believe that the US mortgage market, as contemplated in this bill, will be the template for a newly created system—even if the bill isn’t successful right away. There are rewarding opportunities for private capital to be engaged in the mortgage business. This new system won’t change that—it will just cause the business to take a different form.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Michael S. Canter is Director of Structured Asset Research and Portfolio Management, and Matthew D. Bass is Vice President of Structured Assets, both at AllianceBernstein.