Eric Hathaway, Portfolio Manager on the BlueBay U.S. Fixed Income team, discusses how attempts to restructure two GSEs (Fannie Mae and Freddie Mac) continue to evolve.
Watch time: 4 minutes, 8 seconds
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Hello and welcome back to the Weekly Fix. My name is Eric Hathaway, Portfolio Manager with RBC Global Asset Management’s BlueBay Fixed Income Team in Minneapolis, Minnesota.
This week we’ll be covering the ever-evolving topic of GSE Reform, and answering three questions:
#1 – How did we get here
#2 – Where do we stand today
#3 – What does this mean for the Agency mortgage market
Fannie Mae and Freddie Mac guarantee around 70 percent of the U.S. mortgage market, playing a crucial role in making homeownership accessible for the average American. Back in 2008 as the Global Financial Crisis unfolded and housing prices declined sharply, Congress granted the FHFA the authority to regulate Fannie and Freddie. Soon after both entities were placed into conservatorship, solidifying their link to the U.S. government. Fast forward almost 17 years and their status remains unchanged.
President Trump has been clear about his desire to end conservatorship. In fact, during his first administration plans were drawn up to do just that – only for them to be shelved after the onset of the pandemic in 2020.
This brings us to our second question – Where do we stand today?
There are essentially two paths forward: an exit of conservatorship and a full privatization. An exit would end FHFA’s oversight, while likely preserving the government’s implicit guarantee, meaning the government could still step in during a crisis as they did in 2008. On the other hand, a privatization would go a step further making Fannie and Freddie fully private companies with no government backing or implicit guarantees.
How this unfolds largely depends on two key figures – Scott Bessent, the newly confirmed Treasury Secretary and Bill Pulte, the nominee for FHFA Secretary. Bessent has publicly stated that conservatorships should not be permanent, but he has also acknowledged that he needs further briefings on the matter. Pulte’s stance remains unknown, and his confirmation hearings will be crucial in shedding light on his views.
So on to question #3 – so what? What does this mean for agency mortgages?
As I mentioned earlier these two agencies guarantee around 70% of the outstanding mortgages in the U.S., which translates to nearly 8 trillion dollars. Any structural change to their role in the market could have significant consequences, not just for investors but for borrowers as well. The impact will depend heavily on how capital treatment of agency mortgages is handled going forward. Banks are among the largest holders of these securities, amounting to nearly 2 trillion in assets. One of the main reasons banks hold MBS is because they require lower capital reserves, making them more attractive investments. If capital requirements increase, banks may reevaluate their holdings leading to reduced demand and wider spreads in the market. Another potential risk to full privatization is a credit rating downgrade. Without government backing, Fannie and Freddie could see their credit ratings lowered, causing investors to demand a higher risk premium. This, in turn, would widen MBS spreads and increase mortgage costs for American homeowners.
Ultimately, we believe these risks are relatively remote. Over the coming years we expect progress towards an exit from conservatorship, but any transition will likely be designed to minimize disruptions to the current functioning of the mortgage market and homebuying process. This means capital ratios should remain unchanged, and rating downgrades limited. The mortgage market seems to believe this as well, with spreads little changed since the election.
At RBC GAM we manage a variety of strategies which include Agency mortgages. Thanks for joining me on this edition of the Weekly Fix as we discuss topics shaping markets and your investments.
Key points
Fannie and Freddie play a crucial role in the $8 trillion US mortgage market.
During the Global Financial Crisis in 2008, both entities were placed into conservatorship, solidifying their link to the U.S. government.
Removing these agencies from conservatorship would keep the implicit government guarantee in place, but fully privatizing them would remove this support.
Any structural change to the agencies’ role in the market could have significant consequences, not just for investors but for borrowers as well.