The Cost of Resolution at Fannie and Freddie

The Obama Administration recently announced their proposed plans for the mortgage market and the housing finance agencies, Fannie Mae and Freddie Mac. The plan included three options and a general framework to be decided by Congress. While the Republicans and Democrats disagree on many issues, there is one thing that everyone agrees is true. The government should not continue to provide an explicit back-stop 90% of the mortgage market.

The path to housing recovery is the most contentious part of the discussion. Republicans would like to cut off support to Fannie and Freddie immediately and wind them down over the next 5 years, eventually replacing them with a fully private system. Democrats agree that their size needs to be reduced, but argue that, at least in the short-term, it would be ill-advised to completely dismantle the $5 trillion mortgage securitization engine that they have become.

This position by Democrats has been solidified by the extension of the HARP program by the Obama Administration, which allows underwater homeowners to refinance their Fannie Mae and Freddie Mac loans at today's ultra-low rates. As long as these government support programs continue, the Government Sponsored Entities (GSEs) will need to be working towards the goal of modifying mortgages, while also attempting to achieve the wind-down that was mandated with their Conservatorship Agreement.

In addition to the political debates around the future form of the GSEs, many third-parties are now weighing in and voicing their concern about the suggested destruction of Fannie and Freddie. Bill Gross, the legendary bond investor and founder of PIMCO wrote a blog piece last September discussing the ramifications of destroying the GSEs. His stance is that without government supporting the mortgage market by endorsing the 30-year fixed-rate mortgage, consumers would end up paying 300 to 400 basis points more in interest expense on their mortgage debt.

In layman's terms, this is 3 to 4% more coming out of borrower's pockets. For a $200,000 mortgage loan, this would boost your payments from about $1,250 to $1,650 per month. The added interest cost per year would be in the $4,800 range. So, why would anyone want to eliminate this subsidy? The cost, of course.

Fannie and Freddie have taken about $130 billion in funds from the Treasury to cover losses. This amount is tremendous, but as of now, the FHFA estimates that losses on the portfolio have peaked. Assuming a modest $20 billion in additional losses, we'll reach $150 billion in losses on their $5 trillion plus portfolio of mortgage securities and guarantee pools. Now, do the math and you'll see that this is only about 3% of the entire portfolio ($150 billion/$5 trillion). The current cost to taxpayers is equal to one year's savings for borrowers (3% savings and cost), which is a drop in the bucket. Over ten years, the GSEs will save borrowers $1.5 trillion, assuming a 3% savings rate on mortgage interest.

The next time I hear someone complain about the cost of bailing out Fannie and Freddie, I'm going to pull out my pocket calculator and explain this math to them.  

• Fractured Committee Debates Housing Finance
• Treasury Will Make Profit on Fannie and Freddie MBS
• Fannie and Freddie, Conservatorship Agreement Transparently Violated
• The Cost of Resolution at Fannie and Freddie
• Recent Supreme Court Cases May Affect GSE Outcome
• Fannie Mae and Freddie Mac Shareholders Organize

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• Trading Cramer's Lightning Round - March 15, 2011
• Trading Cramer's Lightning Round - March 11, 2011
• Trading Cramer's Lightning Round - March 10, 2011
• Trading Cramer's Lightning Round - March 9, 2011
• Trading Cramer's Lightning Round - March 8, 2011
• Trading Cramer's Lightning Round - March 7, 2011