Lines Blur Between Primary And Secondary Markets
By 2003, $800 billion in mortgage principal
will be in the portfolios of Fannie Mae and Freddie Mac. That will force
many lenders to leave the mortgage business entirely.
By Bert Ely and Peter Wallison
Since Fannie and Freddie are growing faster than the mortgage market itself,
their growth comes from taking market share, revenue and profits from
genuinely private-sector mortgage lenders.
To maintain their rate of profit growth on which their
stock price depends, Fannie and Freddie must encroach further and further
on the private sector. Although they had previously concentrated on the
best and most creditworthy loans within the conventional/conforming sector
- leaving to the banks, S&Ls, and other nonsubsidized lenders the
subprime, home equity and multifamily loans that represent greater default
risks - they are now compelled to wade into that market and begin to take
market share from the companies that are already there.
There are problems confronting Fannie and Freddie’s private sector
competitors. The GSEs’ share of all residential mortgages (conventional/conforming
and “all other”) will grow from 19.5% at the end of 1998 to
almost 36% at the end of 2003. That increase of 16.4 percentage points
would equal approximately $800 billion, or 12.4% of the aggregate principal
amount of all mortgages outstanding at the end of 2003.
In other words, in four years, $800 billion in principal amount of mortgages
- which would otherwise be in the portfolios of private-sector lenders
now operating in those markets - will instead be in the portfolios of
Fannie and Freddie.
That will substantially reduce the mortgage supply for the lenders now
in the market, and will force many of them to leave the mortgage lending
business entirely.
Nationalized markets
In effect, the growth of Fannie and Freddie is leading to a steady nationalization
of the residential mortgage markets in the United States, without any
debate - or even apparent awareness - by Congress.
Fannie and Freddie must take most of the growth in mortgages outstanding
if they are to meet their market share, revenue and earnings growth objectives.
Since they cannot meet their needs for product solely out of the conventional/conforming
mortgages that will come to market between now and 2003, they must look
elsewhere for product.
One easy target would be the jumbo market, which will become available
if Congress can be induced to eliminate the ceiling on conventional/conforming
mortgages. Opening the door for Fannie and Freddie to enter the jumbo
mortgage market would, by 2003, give them access to almost $1 trillion
of mortgages that are now off-limits.
Other mortgage markets beckon to Fannie and Freddie, including those to
be accessed by dipping deeper into the subprime loan pool and assuming
the higher credit risks associated with those loans; by expanding more
aggressively into the financing of multifamily housing designed for renters,
not homeowners; and by acquiring home equity loans in addition to first
mortgages. But those can be merely stopgaps.
Our projections extend only through 2003; if the growth of Fannie and
Freddie continues beyond that year at the rate Frank Raines has forecast,
they will at some point acquire all the available residential mortgage
product in the United States. As the practical limits of the residential
mortgage market are reached, one can easily envision Fannie and Freddie
arguing that they should extend their skills and cost advantages into
the commercial mortgage market. After all, many office building and shopping
center owners would welcome the taxpayer subsidy Fannie and Freddie can
deliver.
Targeting home equity Fannie and Freddie’s other opportunity for
growth outside the residential mortgage market is to provide financial
services generally, especially consumer credit services. Home equity loans,
for example, provide a ready entry into consumer financial services.
Once the GSEs hold a home equity loan, they have the opportunity to use
it as a revolving loan fund with which Fannie and Freddie would be able
to supply credit directly to the homeowner/borrower. Although in one sense
that might be considered loan origination, such a determination would
have to be made by HUD, which in the past has shown little appetite for
challenging Fannie and Freddie’s expansion. If in fact that activity
goes unchallenged by HUD, the GSEs could become very large sources of
consumer credit, and through their implicit government subsidy they would
be able to offer consumers better rates than banks and other consumer
lenders.
Perhaps the greatest competitive threat, however, remains in the mortgage
origination process. Although Fannie and Freddie vigorously deny that
they have any intention to originate mortgages, pointing out that they
lack the statutory authority to do so, what exactly constitutes origination
of a mortgage is a matter of interpretation. If Fannie and Freddie were
to open their automated underwriting facilities to direct borrower access
over the Internet, it might be possible for them to provide the prospective
home buyer with a certification that his or her mortgage would qualify
for purchase by Fannie or Freddie. At that point, the actual lender would
have little to do except to perform the ministerial acts necessary to
fund the loan and deliver it to one or another of the GSEs. The compensation
for the role would of course be small.
Changes in offing
In a November 1999 speech to securities analysts, Leland Brendsel, the
chairman of Freddie Mac, referred in rather vague terms to major changes
in the offing for the mortgage market:
“I can safely predict that within a few short years, the mortgage
industry will change dramatically. When the dust settles in the mortgage
market we will be left with an industry structure where investor funds
flow to consumers with little drag from antiquated, inefficient processes.
Consumers will be able to tap global capital markets at even lower cost
than they can today.”
And later in the same statement he was even more explicit. Citing the
potential of technology “to streamline the entire mortgage process
and eliminate inefficiency in the housing finance system,” he continued:
“Freddie Mac has brought tremendous efficiency to the mortgage market,
but the industry still generates significant costs from redundant operations
and expensive transfer of information through all the steps in the mortgage
process. As technology wrings out remaining inefficiencies, Freddie Mac’s
role will be enhanced, as we deliver low-cost funds to consumers even
faster and more effectively.”
There can be little doubt that Mr. Brendsel was describing a mortgage
industry in which, through technology, Freddie Mac would be dealing directly
with borrowers and perhaps with consumers generally.
(Ed. Note: This article is excerpted with permission from a booklet published
by the American Enterprise Institute. The pamphlet, titled: “Nationalizing
Mortgage Risk: The Growth of Fannie Mae and Freddie Mac,” may be
ordered by contacting Publisher Resources Inc., 800/269-6267.)
Bert Ely is a financial-institutions and monetary-policy consultant in
Alexandria, Va. He can be reached at: (703) 836-4101. Peter Wallison is
a resident fellow at the American Enterprise Institute for Public Policy
Research where he co-directs the Program on Financial Market Deregulation.
He can be reached at: (202) 862-5848.
This article was previously published in the March 2000 Issue of Secondary
Marketing Executive.
