In the last eight years, Fannie Mae and Freddie Mac have guaranteed at least half of all new mortgage originations. In a report released on Thursday by the Urban Institute (UI), authors Laurie Goodman, director of Housing Finance Policy Center at UI and Karan Kaul, a research associate at UI determined that the two GSEs play an important, indisputable part in the U.S. mortgage market, but also pose a huge risk to taxpayers.
“For the last three years, the GSEs’ conservator, the Federal Housing Finance Agency (FHFA), has required both entities to transfer an increasing amount of mortgage credit risk to private investors,” the authors said. “These efforts to reduce taxpayer risk have been very successful, but three innovations in the past 14 months have been extremely effective, suggesting an even larger role for these deals in the coming years.”
Currently, the government funds 71 percent of new mortgages through the GSEs and the Federal Housing Administration (FHA), compared with 32 percent 10 years ago, the authors noted. While this increase is a significant reduction from the high of 89 percent in 2009 after the financial crisis hit, it still means that taxpayers are on the hook for $5.7 trillion in mortgage debt. The high risk of exposure for taxpayers makes getting private capital back to its traditional role in the mortgage market an urgent and unfinished task of housing finance reform.
According to the report, comprehensive GSE reform cannot be completed without Congressional action, which is currently stalled. Instead, the GSEs are working to transfer their risk to private investors through specific credit-risk transfer deals.
Fannie Mae and Freddie Mac have completed more than 20 capital-market risk transfers and have transferred credit risk on nearly $700 billion worth of mortgages on their balance sheets since July 2013, the report stated. Freddie Mac has transferred credit risk on $343 billion of mortgages, or 22 percent of its book of business, through its Structured Agency Credit Risk (STACR) capital markets transactions, while Fannie’s $350 billion through its Connecticut Avenue Securities (CAS) transactions represents over 13 percent of its book of business. The massive size of these risk-sharing deals prove their success, but GSE innovations have moved the deals into a positive way forward for the housing reform.
“GSE risk-transfer has made tremendous progress during the last three years, placing private capital in the first-loss position and bolstering taxpayer protection,” the authors concluded. “Risk transfer remains in its infancy, however, so we expect to see more innovations on STACR and CAS transactions, as well as more risk sharing at the point of origination to further reduce taxpayer risk. While no one knows what the longer-term future of housing finance will look like, we expect credit-risk transfer to play a critical role.”
Three changes show the potential future of risk transfer:
- The deals are no longer limited to the least risky mortgages. Mortgages with a loan-to-value ratio of over 80 are now included as well.
- Private investors are now willing to share the first-loss risk with the GSEs.
- Private investors are now willing to accept actual, rather than a predetermined