Fannie Mae Guarantees Debt from Small Lenders

In the wake of the credit crisis, a wave of consolidation in the mortgage lending industry has left only a handful of large firms standing. As a result, Wells Fargo, Bank of America and J.P. Morgan Chase collectively dominate mortgage lending, accounting for half of all new loans. Wary of both the structural risks and obstacle to competition that this represents, Fannie Mae is moving to provide a leg up to small, community-based lenders.

Towards that end, Fannie will effectively guarantee all-short term debt issued by such lending institutions, provided that funds received from such debt issuance is used to originate new mortgages that meet Fannie’s lending standards. It should be noted that in most cases, Fannie Mae (and/or its counterpart, Freddie Mac) already guarantee the majority of the mortgages issued by such lenders. While this protects the mortgages that the lenders originate, it doesn’t protect the lenders themselves. Thus, this program, will make it easier for small lenders to raise capital to fund mortgage-origination activities by guaranteeing their solvency.

The upshot is that this should not only increase overall mortgage lending activity, but also enable smaller lenders to compete more effectively more with the big boys. Previously, small lenders were hoarding existing capital and having trouble raising new capital, since investors were rightfully worried about the viability of the loans that they were making. For better or worse, this initiative means that they should be able to offer new mortgages at lower rates and less rigid lending standards.

Certainly, this program is not without its critics. The WSJ has suggested tongue-in-cheek that the government should just go ahead and nationalize the entire mortgage lending industry given that it is now directly responsible for ensuring its functioning. “Fannie and Freddie’s guarantees and subsidies helped to create the housing disaster, which has led the Fed directly to purchase mortgage-backed securities and mess up the market for small mortgage lenders, which in turn is leading Fan and Fred to guarantee the debt of those small lenders,” summarized its editorial board.

For those of you contemplating a mortgage, this means that you can obtain one from a small lender, without worrying about whether it will still be in business tomorrow. There’s no longer a substantial advantage associated with taking out a mortgage from a “Big-Box” lender, since smaller lenders can now compete on terms and pricing. In fact, given the bureaucracy of large lenders, it might be smoother to simply work with a regional/community lender, with which it will be easier to work with in the event of a problem.