Market News Update - Kill Fannie and Freddie?

This week’s newsletter is going to be a change of pace.  Instead of reporting all the prior week’s market data, I thought it would be great to comment on the, once again, hot topic of eliminating Fannie Mae and Freddie Mac.  I hope you enjoy this special report.

The shouting from the mountain top of “kill Fannie Mae and Freddie Mac” was quiet for most of 2013.  However, since President Obama once again brought up the topic in his August 6^th economic speech, the screamers have returned.  The President stated that he wants both entities eliminated by 2018.

As much as both Republicans and Democrats are, for the most part, in agreement on this matter, no one, and I mean no one in Congress or the White House really understands 2 major challenges:

1.     How to accomplish it…

2.     The ramifications of the elimination of these government sponsored entities…

To address the first challenge of how to accomplish it…the irony that exists is that government wants to privatize mortgage financing and the secondary market and remove government involvement; however, what they don’t want to do is reduce the amount of regulation and control they have on it.

The question that needs to be answered is why would any private company want to get involved in the privatization of the secondary market when they will be subject to more regulation and they will be hard pressed to make more money doing it than with the current system that exists with Fannie and Freddie? 

Because of the market meltdown, I certainly agree that more regulation was needed for the mortgage industry as a whole.  However, many laws are now in place to protect consumers and many more are on the way.  When you add all the new regulation on top of even more regulation on how private companies will be permitted to operate in the secondary market, you would have to wonder how does it make financial sense for private companies to do this?  The system the way it is right now is very profitable for companies in the secondary market.  These same companies would be the ones taking the secondary market private; however, the ability to make more money in exchange for the increased work and risk is just not there, as will be explained in the next paragraph.

The second major risk to the privatization plan is that if a company is going to take on the additional risk and regulation of backing mortgages so Fannie and Freddie can be eliminated…then they are going to want to make more money doing it. 

Smart business dictates that if a company is going to want and/or need to make more money because of the inherent risk of this business, well then, they are going to charge more for their services.  Simply put, this means that the cost for borrowing by consumers will have to increase (Rates will rise).  Many experts believe that the privatization of the secondary market will increase mortgage rates by 1% or more.  (Isn’t one of the objectives to keep mortgage rates as low as possible?)

The private companies will start out with setting their profit margins low to keep elected officials happy.  Then as time goes on, they will gradually increase their margins, and the cost of borrowing for consumers will increase.  If you doubt what I am saying, just take a look at the airline industry.  They have been found guilty many times over the years to be in collusion in regard to airfares.  They get a slap on the wrist for doing it and they engage in it once again, only they get better each time at covering their tracks.

Unfortunately, our elected officials are more focused on just getting Fannie Mae and Freddie out of their hair, but they are not looking at the long term impact of the cost to consumers.