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SecuritizationRMBS

GSE reform back on the table under Republican rule

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The long term future of government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, and the potential to finally recast their role in US housing finance, is back on the agenda under a newly emboldened Republican legislature.

The election of Donald Trump, combined with Republican majorities in both the Senate and the House of Representatives, means that there may be an attempt at trying solve the long thought impossible conundrum of ending GSE domination of US housing finance and bringing Freddie and Fannie out of conservatorship.

Critics of the post-crisis status quo have said that the US has what equates to a nationalised housing market controlled by a government owned duopoly. Critics say that this curtails private mortgage lending, and has all but shuttered the market for private label RMBS.

However, proponents of the system point to the stability created by the stewardship of the GSEs and the successful transfer of risk to capital markets through programmes such as Fannie and Freddie’s credit risk transfer (CRT) bonds.

Freddie's STACR programme and Fannie's CAS shelf regularly allow mortgage investors to gain access the US housing market at volumes that were not possible before the inception of CRT in 2013. Regular issuance of the bonds has become a staple of the RMBS market since then. 

The issue of reforming the GSEs is a thorny one, but there is a consensus among Republicans that change is long overdue. With a Republican held legislature emboldened by the president-elect's vows to curb government involvement in financial markets, reform could be around the corner.

GOP views diverge

However, it is unclear what reform measures will look like, as competing groups within the Republican party have offered up divergent views. 

An ideological wing of the GOP in the House, which operates under the leadership of House Financial Services Committee chairman Jeb Hensarling (R-Texas), is likely to compete against a more moderate wing of the party in the Senate, led by Senator Bob Corker (R-Tenn).

Both Corker and Hensarling have spoken publicly about the need for GSE reform, and have both been mentioned as possible cabinet picks for the incoming administration.

Hensarling would likely want as little government involvement in housing as possible while Corker’s views revolve around replacing the duopoly with a different form of government backstop that provides greater taxpayer protections.

The key to a timeline for reform could rest on whether the Republicans choose to use their newfound momentum to tackle the issue of easing Dodd-Frank before moving to the trickier issue of the GSEs.

“The probability of something happening [on GSE reform] is much higher under a Trump administration than it would have been under a Clinton administration,” a Washington lobbyist told GlobalCapital. “Although how quickly it happens will depend on who gets put in charge of the FHFA and whether Hensarling comes out and says anything in the near term," he added, saying that an easing of Dodd-Frank would likely take precedent over GSE reform.

The president-elect has said little on Fannie and Freddie, so it is likely that any movement on GSE reform would start at a congressional level. This means it will be up to the GOP in Congress to come up with a solution.

“The question will be whether the two wings of the party, which is essentially the Senate leadership and the House leadership, will view this as important enough to be willing to sit down and work out their differences in order to figure out what a compromise looks like,” says Jim Parrott a senior fellow at the Urban Institute and owner of Falling Creek Advisors.

“If they don't prioritise it at a high enough level, then my guess would be that the differences in the Republican Party will be just as intractable as the differences we have seen between the parties.”

Parrott, who has co-authored a number of papers on GSE reform for the Urban Institute, noted that while the political dynamic has shifted to the right after the election, that side of the spectrum is no less complicated than the gridlock between the parties that had been the status quo until last week.

One solution that could be on the cards is a merger of the GSEs, floated by the Urban Institute in paper published in December.

“[A GSE merger] is one theory how most rationally to organise or structure the government's role in the market, said Parrott. “There are a number of different ways you can do that. You can do it by allowing for multiple guarantors or creating a utility which can oversee it, or you can do it through a government corporation which manages the infrastructure.”

That solution might not please ideologues who would rather see the government exit the housing market entirely, but would avoid a situation that replicated conditions that led up to the 2008 financial crisis.

"We would argue that the alternatives to [the government corporation] model almost inevitably lead to significant too-big-to-fail risk,” Parrott added. “That is a largely non-partisan argument. It's more saying that we think that the government's role in the market is most rationally organised in this system and if you organise in one of those other ways [considered in the report] you will likely be replicating much of the risk which got us in to trouble in the first place.”

Following Trump’s victory, another possible solution has been a recapitalisation and release of the GSEs.

Shares in both Fannie and Freddie surged higher after the election, and investors in the GSEs have expressed optimism in a solution that returns them to private market control.

Pershing Square CEO Bill Ackman, who has a significant stake in the GSEs, predicted that the new president-elect would reach a deal on the agencies in the first 12 months of his administration, one that would result in a positive outcome for GSE shareholders. 

However, of all the existing options for GSE reform, recap and release is perhaps the least popular in Washington, DC, and any deal that would return Fannie and Freddie to investors on the cheap would likely be politically unpopular.

Parrott added that even if the recapitalisation play did gain momentum, there are some in the GOP that remain “deeply antagonistic” towards the strategy.  

Aside from the political blowout, recap and release would also likely be expensive.

“I'm sceptical that we will see a significant recap and release just because the cost is so high,” said the lobbyist. “We don’t know where that money would come from. I also don't think that with everything else Trump is talking about spending money on, particularly infrastructure, that there is a huge appetite to spend $10bn or more to recapitalise the GSEs and release them.”

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