I recently wrote about how the housing bust has affected our industry and its prospects for 2008. I have been asked many times, “So, if the reason for this bust is the mortgage market, how will we ever dig out of this mess?”
Well, I believe the key to the housing recovery will be the traditional government-backed mortgage markets. And there are already signs that these federal institutions have stepped into the breach of the mortgage mess to provide relief.
Since the Great Depression, the federal government has supported the mortgage financing markets for homeowners. That role was diminished amid the frenzy of the recent housing boom, when Wall Street eagerly provided capital for lending. But with that game over, the government's historical role is expanding again.
Despite America's free market system, politicians have long felt that housing was too important to be left exposed to the full effect of market forces. Congress has always overwhelmingly backed the Federal Housing Administration (FHA), Fannie Mae, and the Home Loan Banks, all created during the Depression when banks failed and mortgage credit evaporated. Freddie Mac was created in 1970 to supplement Fannie Mae's role.
When this housing boom arrived, many believed that Fannie and Freddie seemed destined for smaller roles. The Wall Street Journal reported this past fall that investment banks started dominating the lucrative business of bundling home loans into securities for sale to investors worldwide.
The private banking group did a good job. Total U.S. outstanding residential mortgage debt swelled to $10.3 trillion at the end of 2006, almost double six years earlier. Some even speculated whether the government-backed agencies were relevant anymore.
Helping Fannie and Freddie
Today, the winds have changed, and these private lenders are also leaning more heavily on the government-backed agencies. To clarify, Fannie Mae, Freddie Mac, and the Home Loan Banks are not government agencies. But because of their federal charters, many assumed the government would bail them out in a crisis.
The loans made by the Home Loan Banks to financial institutions grew 29% in the first nine months of 2007, to $824 billion. Among U.S. mortgage securities offered to investors, the portion guaranteed by Fannie and Freddie has rebounded to around 72% in October from as low as about 41% in 2005 at the height of the housing boom, when Wall Street gobbled up loans with no federal backing.
In one telling trend, Countrywide Finance reports more than 80% of the loans it is making now are eligible for sale to Fannie or Freddie, up from about one-third last year. Also, the FHA has recently resumed a bigger role in providing insurance against mortgage defaults.
Its share of the market for home loans packaged into securities fell to less than 2% in 2006. But experts believe that figure is likely to rebound to more than 10%, assuming Congress passes legislation giving the agency the ability to insure larger loans.
Fannie and Freddie buy and guarantee repayment of mortgages only up to $417,000. But in recognizing growth in housing values over the last decade, the Federal Reserve has proposed expanding the government's role even further by providing guarantees against defaults on jumbo loans. Those loans are above the $417,000 limit on mortgages that Fannie or Freddie can back.
The idea is that Fannie and Freddie would package the loans into securities, but the federal government would provide the guarantee. It appears Congress is preparing legislation to expand the jumbo loan limits.
There's a long way to go before the housing inventory glut ends. But when it does, expect the traditional, government-backed mortgage markets to lead the way in financing the recovery.