The $400 million case for a single GSE security
Fannie Mae and Freddie Mac (the government-sponsored enterprises or GSEs) keep capital flowing for mortgage lending by buying, guaranteeing and pooling mortgages and then selling mortgage-backed securities to investors. Currently, both entities issue their own separate securities, but their conservator, the Federal Housing Finance Agency (FHFA), has put forth a plan to have both entities issue and guarantee a single security. FHFA’s single security proposal is well-thought out and worthy of serious consideration and support by all the key stakeholders.
In August, the FHFA issued a request for input on the proposed structure of a single security for the GSEs. Currently, each entity’s securities have different features and trading prices. Freddie Mac’s securities are less liquid, and thus less desirable. To keep its market share, Freddie is forced to subsidize the fee paid by lenders for its guarantee, the cost of which is ultimately borne by US taxpayers. The development of a single security, described by the FHFA as a “multi-year” project, is intended to eliminate the liquidity differential and hence the cost differential to save taxpayer dollars.
While this may seem like an obscure technical issue, it is actually a critical initiative for three reasons, discussed more fully in our recent commentary.
- This initiative will save the US Treasury between $400 and $600 million per year, the amount Freddie Mac is forced to pay to its originators to keep its market share.
- Fannie’s current price advantage undermines competition and renders the market less responsive to the needs of borrowers and lenders. Moving to a single security would remove that advantage, boosting competition, with potential benefits to mortgage rates and the availability of mortgage credit.
- Moving to a single security could help pave the way for GSE reform. The development of the Common Securitization Platform (CSP) and a single security means that market participants in a new system will not need to provide their own securitization infrastructure, as Fannie and Freddie do today.
Under the single security proposal, Fannie and Freddie would each issue securities under the CSP currently under construction by the GSEs. The securities would have identical characteristics, which would combine the best features of each of the current securities. Thus, the new security would have the superior pooling features of the current Fannie Mae securities and the superior disclosure features of the Freddie Mac securities. After a certain date, both entities would issue only securities with these features. To ensure maximum liquidity, legacy securities would be fungible with the newly issued single securities. It is expected that legacy Fannie securities will not need to be converted to the new security; legacy Freddie securities could be converted at any time.
The most interesting part of this proposal is the ability to place Freddie Mac securities into Fannie Mae re-securitizations, such as Megas (pools backed by Fannie Mae securities, not loans) or Real Estate Mortgage Investment Conduits (REMICs), and Fannie Mae securities into Freddie Mac re-securitizations, such as Giants (pools backed by Freddie Mac securities, not loans) or REMICs. This structural option makes it makes it very likely that the securities backed by the entities will trade equivalently.
That is, if Freddie securities traded cheaper, dealers and investors would be able to deliver their Freddie securities into Fannie Megas; the ability to do this would keep price spreads in line.
Note that The Securities Industry and Financial Markets Association (SIFMA) must endorse a proposal to make a “single security” good delivery in addition to or in substitution for existing Fannie Mae or Freddie Mac Securities. However, since under the proposal, Freddie’s and Fannie’s would be good delivery into re-securitizations of the other, SIFMA would have to change existing rules for the express purpose of blocking this alternative, which seems unlikely.
While we are concerned that the FHFA may be contemplating a slower pace in the project than it warrants, the request for input charts out a thoughtful path to a single security. The path charted makes it likely to succeed ultimately —to the benefit of taxpayers, borrowers, and lenders.
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