Mortgages in the U.S. are essentially nationalized, with the government running the show.
Today there are $14 trillion in outstanding residential mortgages. Of these, 90% are “controlled” by government agencies including the Federal Housing Administration (FHA), the Department of Veterans Affairs, Fannie Mae and Freddie Mac…
However, most mortgages are backed through two private companies known as Government-Sponsored-Enterprises or GSEs. As you likely know, these companies are owned by the shareholders, but have the complete financial backing of the U.S. government.
Even after the housing boom and bust, Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FHLMC) are still alive and kicking. Today, these two GSEs own or guarantee repayment on roughly half of all mortgages. If you have a mortgage, chances are that the taxpayers – by way of Fannie or Freddie – guarantee your mortgage.
We all know from the housing debacle that this means shareholders of Freddie and Fannie reap the profits while the taxpayers pay for the losses. Indeed, a recipe for disaster, and one that screws the U.S. taxpayer.
All of this has led to the recent push for privatizing the mortgage market by the U.S. Congress and Obama administration.
Earlier this week Obama called for more security for taxpayers. Obama said that companies should not expect bailouts for bad decisions. He also advocated for simple and safe mortgage products like the 30-year fixed rate mortgage should be protected.
Giving a speech in Arizona, the President said "First, private capital should take a bigger role in the mortgage market. I know that sounds confusing to those who call me a socialist — I saw some posters when I came in — but I actually believe in the free market… Private lending should be the backbone of the housing market."
The question is whether privatization can work?
Look no further than Europe for the answer.
That’s because Europe provides compelling evidence that private markets can provide the necessary supply of credit to sustain active housing markets. That’s because every European country has a good private mortgage markets without government support.
This private approach seems to be working well. For evidence, look no further than extremely low delinquency and foreclosure. European lenders, borrowers and taxpayers all recognize that high underwriting standards prevent the need for government bailouts and mortgage guarantees.
The U.S. can and will create a sound and vigorous private mortgage market. But no private market can compete with the government-guaranteed and subsidized markets of today.
So, how do we get from here to there?
First, the government should lower the maximum amount of a mortgage loan that Fannie or Freddie can hold or securitize by a fixed amount say $75,000. As its loan size limits decline, so will the Fannie and Freddie’s market share. Eventually, their share will reach zero and the market will be privatized. With a government exit plan announced in advance, private lenders have time to expand their lending activities.
As a result, borrowers will likely pay a slightly higher mortgage rate. Typical borrowers could pay an additional 0.5% in mortgage interest. That would translate into an extra $75 – $135 per month for the average $200,000 home, according various proposals in Congress.
However, a broader menu of choices and increased competition could offset the increase in extra interest payments.
Many European countries offer fixed and adjustable rates, with and without prepayment penalties, alternative amortization periods and so on. There's no reason we couldn't also have a wider variety of choices. And the 30-year, fixed-rate mortgage could remain a favorite of U.S. lenders and borrowers.
At Wyatt Investment Research, we believe that there should be a true “free market” for mortgages. And this means winding down Fannie Mae and Freddie Mac.
Allowing private companies to fill the void left by the GSEs may result in slightly higher mortgage rates for the average homeowner. But for the American taxpayer and health of our economy, getting the government out of the mortgage business would be best for everyone.
Tell me your thoughts on Fannie and Freddie, and President Obama’s plans to exit the mortgage business. Please send me an email at [email protected] with your views and ideas – I would love to hear from you.