The latest on Fannie and Freddie

With the nomination of North Carolina representative Mel Watt to head the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, coverage of the agency and where it is heading was back in the spotlight on Thursday.

Watt, a known advocate of principal reduction for those underwater on their mortgages, may have a difficult time getting confirmed by the Senate, but it will spark a debate on what to do with the government entities.

Here’s an excerpt from the Wall Street Journal:

President Barack Obama said Wednesday that he would nominate Rep. Mel Watt to head the regulatory agency that controls Fannie Mae and Freddie Mac.

His choice appears set for a confirmation battle and debate with Republicans over the biggest unresolved legacy from the financial crisis: what to do with the failed mortgage-finance companies nearly five years after their government takeover.

The director of the Federal Housing Finance Agency has become an important economic-policy post in Washington because the agency serves as the warden of Fannie Mae and Freddie Mac, which own or guarantee about half—or $5 trillion—of all U.S. mortgages. As a result, many of the agency’s decisions now carry unusual sway over the housing sector and the broader U.S. economy.

The mortgage-finance companies, which have cost taxpayers more than $120 billion since they were taken over in 2008, have begun reporting hefty profits in recent quarters.

Consumer advocates and industry analysts said Wednesday they believed that if Mr. Watt is confirmed as head of the Federal Housing Finance Agency, he would work more closely with the White House to expand access to credit for borrowers looking to purchase homes and to refinance underwater mortgages, where homeowners owe more than their homes are worth. Mr. Obama highlighted those two issues in his remarks Wednesday.

But according to Bloomberg Businessweek, reducing principal for many borrowers would do little good. Citing a report from the Congressional Budget Office that Watt himself requested, Businessweek said the effort wouldn’t help as many people as originally thought:

So what did the CBO find? If Fannie and Freddie were to reduce principal for underwater borrowers through the government’s Home Affordable Modification Program, the impact would be positive but tepid. More than ten million homeowners are underwater on their mortgages, yet the CBO estimates only about 200,000 of them would be eligible for principal reduction through HAMP. That would reduce defaults for between 18,000 and 95,000 borrowers, depending on how much the loan balance is lowered. If the principal was reduced to 100 percent of the property’s value, then the government (via Fannie and Freddie) would save $2.8 billion. “Designing a program that affected more borrowers and had a greater impact on the housing market and the economy would require a significant departure from HAMP’s current eligibility rules,” the CBO writes.

The report’s findings are a mixed blessing for Watt and other supporters of principal reduction. Yes, it would help some homeowners and save the government money–but not a meaningful amount. Republicans generally oppose mortgage debt forgiveness, and may use Watt’s support of the idea as a reason to vote against him–saying that not only is it a bad idea, but according to the report, it wouldn’t even make much difference.  And the debate could distract from an even bigger issue with a far wider impact: what the government should do with Fannie and Freddie in the future.

An interesting piece in the Financial Times highlighted recent trading decisions by the two companies as potentially dangerous to the housing market. It’s likely this will at least prompt a line of questioning during Watt’s Senate hearings:

Are Fannie Mae and Freddie Mac about to get caught up in a whole new area of partisan controversy?

The government-controlled mortgage finance giants are often accused of having distorted the US housing market in the run-up to the crash by enabling the rush towards subprime lending.

Now they have been ramping up their activities in a new area – trading commercial mortgages of the kind that developers take out to build or buy apartment blocks.

Think-tanks are warning that the cheap money they are steering into the market may be driving up the price of developments, creating local distortions and setting the US on the road to another housing crash.

The question of what to do with Fannie and Freddie’s commercial mortgage businesses is about to soar up the political agenda with the imminent publication of internal discussion papers about whether these divisions can be privatised.

But strong forces are lining up to prevent such an outcome, including politicians worried they will be accused of pushing up rents, lenders who love the cheap finance, and investors who are addicted to Fannie and Freddie’s government-guaranteed securities.

But others think the programs are helping the markets:

Democrat Mark Warner said Fannie and Freddie’s multifamily operations were important to the market and asked why anyone would tinker with them given that they had not been a contributor to the latest crisis.

The companies say they provide stability of financing to developers, even through violent economic cycles.

Some investors credit Freddie with almost single-handedly reopening the market for commercial MBS, which shut down during the credit crisis.

Given the partisan nature of Washington these days, there is no guarantee that Watt will be confirmed to his new post. But the country is poised for another debate on the mortgage giants and their roles in the housing market, hopefully bringing more transparency to how they use tax dollars. One thing is certain, it should be interesting.