Insolvency Looms for FHA and Fannie/Freddie

As I mentioned in my previous post, one of the big unknowns for 2010 is the role of the government in the mortgage market, especially via the FHA and Fannie Mae / Freddie Mac. On the one hand, these entities now account for a tremendous (and still growing) portion of overall mortgage activity. On the other hand, all are heading towards insolvency, which means their future is in jeopardy at the very time that their existence has grown to become indispensable. For better or worse, the federal government has already come to terms with this reality, and is already moving to ensure their survival.

In response to Fannie and Freddie’s increasingly precarious financial positions, the Treasury Department recently announced that it would no longer cap the amount it could spend to keep them afloat for at least three more years. (Previously, a cap of $200 Billion per institution applied to government bailout efforts.) The move was incredibly controversial, since it deliberately circumvented the Congressional approval that would have been required had the Treasury waited until after the new year to act.

To be fair, Fannie and Freddie combined have received “only” $110 Billion in taxpayer subsidies to-date, so it seems unlikely that it will have to draw upon the complete $400 Billion that had previously been allocated. By removing the caps, however, the Treasury has simultaneously given itself more flexibility and assured the markets that it stands behind the two mortgage buyers. In addition, the funds have not been given away free, as the government has received dividends and stock warrants, as well as full decision-making authority, in exchange for its investment.

As for why the government wants to continue throwing money into these two black holes, well, that’s not difficult to comprehend. As the Washington Post reported, “By promising to keep the companies solvent, the government can maintain its sweeping power over the housing market. Fannie Mae and Freddie Mac have played a central role in Obama administration policies to keep mortgage interest rates low, restructure unaffordable mortgages, stop foreclosures and funnel money to housing programs around the country.” In other words, the federal government’s housing policy is largely being conducted through Fannie and Freddie, and to relinquish control over the two organization (and/or let them slide into bankruptcy) would give it fewer tools to prop up the housing market.

Turing to the FHA, the federal government also has a plan, though it’s slightly different. Rather than pump taxpayer money into the beleaguered organization, the government is more likely to implement certain “austerity” measures, so that it can remain self-sufficient. Whereas there’s no pretense that Fannie/Freddie can survive without the assistance of Uncle Sam, the goal is to make it so the FHA can remain solvent without an outside capital infusion.

Towards this end, it will probably raise down-payment requirements, so that borrowers “have more ‘skin in the game‘ and a stronger equity position in their loans.” Credit standards will probably raised (in order to mitigate against the possibility of default), as will mortgage insurance premiums. FHA mortgage rates – currently hovering around all-time lows – shouldn’t be affected.

As for the long-term plan for all three entities, it appears that they will gradually return to a mission of helping low-income borrowers – a mission that FHA has moved away from, but that Fannie/Freddie have actually moved towards, in recent years. As for everyone else, well it looks like you’ll soon be on your own.