Securities analysts and others who keep close tabs on the Federal National Mortgage Association have expressed some concern recently that the U.S. government's decision to make direct student loans in competition with Sallie Mae might set a precedent that could bode ill for Fannie Mae. Analyst Gary Gordon of PaineWebber Inc. dismissed such fears in a recent article in the firms "Porfolio Manager's Spotlight."
Fannie Mae's stock has suffered this year from the travails of Sallie Mae. Sallie Mae went from a company with a significant advantage to its competitor banks to a company with a significant disadvantage to its soon-to-be competitor, the U.S. government.
However, we believe that Fannie Mae can sustain its advantage. Fannie Mae's advantage is a political one -- the government provided Fannie Mae and Freddie Mac a better debt guarantee than it has provided to the banking and thrift industries.
For Fannie Mae to retain its political advantage, a political consensus needs to be sustained that the agency benefits the key affected parties.
So Far, So Good
The company has been successful in creating and sustaining that consensus among mortgage companies, borrowers, investors, and low-cost-housing advocates.
Fannie Mae's role in the mortgage market is to maintain liquidity and to some extent to establish underwriting standards for the industry. The private-sector beneficiaries of that role are mortgage bankers, realtors, home builders, brokerage houses, and investors.
Even banks and thrifts, which are competitors, have become happy suppliers (by selling their loans to Fannie) and customers (by buying mortgage-backed securities). Only selected thrifts complain that Fannie Mae is a dangerous competitor.
3 Historical Benefits
Borrowers have been greatly helped by Fannie Mae in three ways. First, Fannie Mae's debt guarantee has been translated into a cost saving for borrowers of generally 25 to 50 basis points on the interest rate paid.
Second, borrowers are able to access long-term financing, namely 30-year mortgages. Third, the mortgage market has the liquidity to absorb huge demand, as is currently occurring because of the refinancing boom.
Finally, Fannie Mae has generally pleased Congress with its efforts to support lower-income housing, though that role will always remain a struggle for Fannie Mae and Freddie Mac.
The contrast to Sallie Mae is instructive. Sallie Mae viewed its role much more as a public company responsible to shareholders to deliver profits. Therefore, it has historically tried to "win" its negotiations with customers and the government, rather than work for a compromise.
Initiative Defeated
For example, last year Sallie Mae "won" by defeating a direct lending initiative because it obtained a veto threat on the whole education bill from President Bush if direct lending was included.
However, Sallie's victory was a defeat for a number of influential Congressmen who had crafted the education bill.
Another example is complaints we have heard from peers in the student lending business that Sallie Mae would purchase only the best-quality student loans.
Unseemly Profits
That "win" -- maintaining a high-quality loan portfolio made losers and, therefore, potential antagonists of lenders who had to make the poorer-quality loans because of government rules but then could not get rid of them. Compare this approach to Fannie Mae's approach to supporting lower-income housing.
We believe that Fannie Mae earns a "fair" rate of return while Sallie Mae probably earns too much. Earning too much seems like heresy to a capitalist. but not to a government that has provided a private-sector firm with support.
For example, President Clinton's primary political weapon against Sallie Mae and its peers was that they earned too much on the student loan program. Fannie Mae's stabilized return on equity is about one-third less than Sallie Mae's.
