The most immediate challenge is what will happen to interest rates when the Federal Reserve terminates its program for purchasing Fannie Mae and Freddie Mac mortgage-backed securities in March. The Federal Reserve has purchased the vast majority of MBS issued by these two companies this year and in September purchased more than 100% of the Fannie and Freddie MBS issued that month. The benefit has been that mortgage rates have been held lower than what they otherwise would have been without the purchase program, but there is growing concern over where rates may go once the Federal Reserve stops buying and what this will mean for borrowers. While the most benign estimates are for increases in the range of 20 to 30 basis points, some estimates of the potential increase in rates are several times those amounts. The extension of the Fed’s MBS purchase program to March gives the Obama administration time to announce its interim and, perhaps, long-term recommendations for Fannie and Freddie in February’s budget release.
All of this, however, points to the need to begin replacing Fannie Mae and Freddie Mac with a long-term solution. MBA has been working on this problem for over a year now and recently released its plan for rebuilding the secondary market for mortgages.
MBA’s plan envisions a system composed of private, non-government credit guarantor entities that would insure mortgage loans against default and securitize those mortgages for sale to investors. These entities would be well-capitalized and regulated, and would be restricted to insuring only a core set of the safest types of mortgages, and would only be allowed to hold de minimus portfolios. The resulting securities would, in turn, have a federal guarantee that would allow them to trade similar to the way Ginnie Mae securities trade today. The guarantee would not be free. The entities would pay a risk-based fee for the guarantee, with the fees building up an insurance fund that would operate similar to the bank deposit insurance fund. Any credit losses would be borne first by private equity in the entities and any risk-sharing arrangements put in place with lenders and private mortgage insurance companies. In the event one of these entities failed, the insurance fund would cover the losses. Only if the insurance fund were exhausted, would the government need to intervene.
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