Fannie Mae and Freddie Mac have guaranteed at least half of all new mortgage originations for the past eight years. The two government sponsored enterprises’ (GSEs) critical role in the US mortgage market is indisputable, but so too is their 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. 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.
Significant taxpayer risk remains
The government currently funds 71 percent of new US mortgages through the GSEs and FHA, compared with 32 percent 10 years ago. While this increase is a significant reduction from the high of 89 percent in 2009 after the financial crisis hit, it still means that US taxpayers are on the hook for an astounding $5.7 trillion in mortgage debt. The extremely high risk exposure for taxpayers makes getting private capital back to its traditional role in the mortgage market a critical, unfinished task of housing finance reform.
Transferring the risk to private investors
While comprehensive GSE reform cannot be completed without Congressional action, which is currently stalled, the GSEs have been working to transfer their risk to private investors through specific credit-risk transfer deals.
Since July 2013, 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. To date, Freddie Mac has transferred a good deal of the credit risk on $343 billion of mortgages (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.
Their size alone indicates the success of these risk-sharing deals, but significant GSE innovations have transformed the deals into a possible way forward for housing finance reform. We’ll explore the future of risk sharing, including further innovations in an upcoming brief, but three changes show the enormous potential future of risk transfer:
1. 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.
2. Private investors are now willing to share the first-loss risk with the GSEs.
3. Private investors are now willing to accept actual, rather than a predetermined, loss.
GSE risk-transfer has made tremendous progress during the last three years, placing private capital in the first-loss position and bolstering taxpayer protection. 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.
For the most recent data on the housing finance market, see our June Chartbook.
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