Does splitting Fannie and Freddie’s platforms make sense?
In February the White House
published a report to Congress mandated by the Dodd-Frank Financial Reform
Bill. The white paper indicated a significantly reduced role for the
government-sponsored entities Fannie Mae and Freddie Mac, winding down their
conventional lending programs and allowing the private capital markets to fill
The paper’s three options
indicate government support of the mortgage markets should re-emerge in times
of crisis. However none of the options clearly ensure taxpayers will be
shielded from billion dollar losses in the event of a future crisis.
Like the Dodd-Frank bill,
the white paper makes only a few distinctions between reforming the
single-family and multifamily mortgage markets. If the ultimate goal is to
privatize both mortgage markets, why is it important to distinguish between
single family and multifamily?
By analyzing the state of
the two mortgage platforms separately, we gain insight into one strategy for
consummating the privatization process. As of third-quarter 2010, the Federal
Housing Finance Agency reported that Fannie and Freddie had drawn $151 billion
of capital through the Treasury Department’s preferred stock purchase program
to bolster the $78 billion the two already held in capital. Of the $229 billion
in total capital between Fannie and Freddie, $175 billion — more than 76
percent — has been used to support guarantees on single-family loans. By
comparison, the GSEs have used only $11 billion in draws, less than 5 percent,
to support guarantees on multifamily loans. Additionally, $5 billion of the $11
billion drawn to support multifamily loans is associated with accounting write-downs
for tax credits, according to FHFA — not actual losses — meaning only $6
billion has been drawn to support multifamily guarantees.
The contrast in performance
is further demonstrated by comparing the GSEs’ multifamily and single-family
loan performances. In 4Q10, the Fannie and Freddie 60+ day multifamily
delinquency rates were 0.71 percent and 0.31 percent respectively, according to
the Mortgage Bankers Association, while the combined 60+ day 3Q10 delinquency
rate for GSE single-family loans was 5.60 percent, according to the Office of
Thrift Supervision’s OCC and OTS Mortgage Metrics Report: Third Quarter 2010.
In addition to
outperforming the single-family platforms, Fannie and Freddie’s multifamily
programs stack up well against other commercial mortgage lenders’ platforms.
The two enterprises have respective delinquency rates of 0.71 percent and 0.31
percent, while commercial mortgage-backed securities’ multifamily delinquency
rates stand at 10.15 percent as of January, according to Realpoint. Life
company delinquency rates were a low 0.19 percent at the end of the 4Q10, while
bank and thrift delinquency rates stood at 4.19 percent, according to MBA.
Now consider origination
volumes: Fannie and Freddie combined to originate $31.9 billion in new multifamily
mortgages in 2010, two-and-a-half times more than the $12.3 billion of CMBS
issuance in all of 2010, according to the CRE Finance Council’s Compendium of
Statistics, and more than 50 percent higher than the $20.3 billion in life
company commercial mortgage commitments during the first three quarters of
2010, according to MBA.
Good Bank/Bad Bank
With Fannie and Freddie’s
multifamily platforms thriving and the single-family platforms costing
taxpayers billions, what strategy should legislators pursue to reduce the
government’s role in the mortgage markets? One approach follows precisely what
the data spells out — reforming and privatizing the multifamily and
single-family platforms separately.
A good bank/bad bank
strategy separates a lender’s bad assets from the performing ones in order to
unburden a company’s healthy and profitable business lines. Because federal
money has almost entirely gone to supporting single-family loan guarantees, the
GSEs simply can split the already distinct multifamily and single-family assets
and operating businesses. Fannie and Freddie’s multifamily platform and assets
could be sold off as a performing enterprise, separate from the single-family
platform. Selling the GSE multifamily programs would reduce political oversight
and bureaucracy, as well as provide a faster path to mortgage market
privatization than a progressive winding down of origination activity.
Additionally, if the multifamily platforms were privatized through a buyout,
the government could use its share of the profits as a capital buffer for the
single-family platform and lessen the need for the preferred stock purchase
program to cover losses.
A rapid privatization could
have drawbacks: Many feel the absence of government support for Fannie and
Freddie would leave a large void in the capital markets, and a buyout of the
multifamily platforms raises concerns over apartment financing availability.
However, the recent resurgence of CMBS and life company lending should
progressively decrease multifamily borrowers’ reliance on the GSEs.
The white paper also notes
that without federal backing on Fannie and Freddie mortgage bonds, interest
rates would be higher and borrowers would suffer. While higher rates may be an
unavoidable consequence of reducing the government’s role in the mortgage
markets, it is a cost necessary to limit taxpayer exposure to financial crises.
The magnitude of Fannie and
Freddie in today’s mortgage markets makes the transition one of the most
complex tasks in reforming the financial markets. During 2011 we hope that
legislators and regulators consider the good bank/bad bank model.
Nick Silbergeld is a vice
president at George Smith Partners, a Los Angeles-based real estate investment
banking firm. Contact him at email@example.com.