Higher fees charged by Fannie Mae and Freddie Mac to bring private capital back in the mortgage market might actually backfire by reducing borrower demand for home loans or by simply shifting the risk of losses to another government agency.
That's the conclusion of a report issued Tuesday morning by the inspector general of the Federal Housing Finance Agency, the conservator of Fannie and Freddie.
The report by the Office of Inspector General Steve Linick shines a light on the charges known as guarantee fees that are embedded in the cost of home loans backed by Fannie and Freddie to protect investors from potential losses. Guarantee fees became something of a political football last year when they were raised to help offset temporary reductions in federal payroll taxes.
But they have become a huge profit generator helping the government-sponsored enterprises repay the taxpayer bailout in 2008. Last year, Fannie and Freddie generated $12.5 billion in revenues from guarantee fees, which have nearly doubled since 2011 to between 50 and 55 basis points.
While no one disputes that g-fees were set too low during the last housing boom, when they averaged about 21 basis points from 2004 to 2007, it may be far too early to determine if raising them will encourage private capital will come back in.
The FHFA has said the intent of raising g-fees is to narrow the cost between what Fannie and Freddie charge lenders to deliver large volumes of loans and what private lenders would pay to package loans into private-label securitizations.
When Edward J. DeMarco, FHFA's acting director, announced guarantee fee pricing increases last year, he said the changes "will move Fannie Mae and Freddie Mac pricing closer to the level one might expect to see if mortgage credit risk was borne solely by private capital."
But the OIG report appears skeptical that private lenders will come back into the market, and indeed many bankers have said the same thing privately, arguing that private investors are unlikely to support the mortgage market without a government guarantee, or backstop, against potential losses.
"Significant guarantee fee increases, under some scenarios, could result in higher mortgage borrowing costs and dampen both consumer demand for housing and private sector interest in mortgage credit risk," the report states.
The report also claims that certain efforts to combat abusive lending practices, such as the Consumer Financial Protection Bureau's proposal to require lenders to ensure that borrowers can repay their mortgages, "could limit private-sector incentives to invest in additional mortgage credit risk."
Michael Kao, the founder and CEO of the hedge fund Akanthos Capital Management in Woodland Hills, Calif., says g-fees would need rise to between 80 and 85 basis points "before private competition would be incented to dip their toe in."
"It definitely doesn't seem like g-fees have been raised enough," said Kao. "We're still in this little protected bubble of subsidized housing and given the fact that Fannie and Freddie's market share has gone from 50% during the housing boom to 90% currently, I would whole-heartedly say that it has not had the desired effect."
The FHFA rejected the OIG's two primary recommendations.
The agency balked at developing performance measures or a specific definition of what constitutes "increased private sector investment in mortgage credit risk."
Sandra Thompson, an FHFA deputy director, said in a June 26 memo that the private-label market is coming back, albeit slowly.
"We have seen a small scale birth of a new issue market for mortgage securities backed by newly originated loans," Thompson wrote to Richard Parker, the FHFA-OIG's director of policy, oversight and review.
The FHFA also disagreed with the OIG's recommendation that it establish a formal working relationship with the Federal Housing Administration to collaborate on pricing initiatives, saying it already does so on an informal basis.
For now, the guarantee fee increases are providing a huge benefit to taxpayers and it seems strange that the inspector general is would suggest that FHFA and FHA collude on pricing. But the problem is that higher fees charged by Fannie and Freddie and having the unintended effect of pushing borrowers to the FHA, which has said it will discontinue further insurance premium increases.
"The potential exists that a resulting pricing disparity between guarantee fees and insurance premiums could shift a portion of (Fannie and Freddie's) mortgage business and its associated risks to FHA's market without an overall increase in private sector investment in mortgage credit risk," the report states.
The report also noted that a lack of communications between FHFA and FHA "has limited the transparency of their respective pricing initiatives [and] consequently there is a limited basis for Congress, market participants and the public to assess," their actions and comment on them.