Top 3 Reasons Fannie and Freddie are NOT Doomed for Destruction

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” I’ve been kicked around
Since I was born.
And now it’s all right. It’s OK.
And you may look the other way.
We can try to understand
The New York Times’ effect on man.”
Bee Gee’s  Staying Alive

Getting the stop sign signal is really important to long-term success in driving… and real estate development.

A key component of rental demand is mortgage availability and preference or aversion to home ownership, so today I’m going to dive deeper into the availability question.  Despite plenty of talk of their demise my bold prediction is: Fannie Mae and Freddie Mac will survive.

There are many who blame the whole sub-prime meltdown on Fannie and Freddie.  Indeed the congressional commission responsible for doing a post-mortem on the sub-prime collapse fell predictably along party lines.  In fact in my estimation the post-mortem based by political philosophy breaks down approximately like so:

Democrats:  Wall Street did it.

Republicans:   Government regulations (ergo Fannie and Freddie) are to blame.

Libertarians:  The Fed did it.  End the Fed.

Me:  What about main street?

Why did the country have a group delusion that a mortgage set at 9% resting at 11% was a grand idea?  The lack of clear answers and political bluster has led me to conclude that all contain elements of truth.  Why does this matter to us here at BiggerPockets?

I am still trying to wrap my head around the scope of the renter nation.  Is it just an ordinary phenomenon that will slightly alter the boom and bust cycle of multifamily?    Is it an era…similar to when we moved from horse and buggies to model T’s?  From a land yacht Lincoln Navigator to a Tesla?

In researching last weeks post I was stunned to learn of the household formation numbers.  It is anticipated that 5.5 Million NEW households will be formed between now and 2016 with a full 70 percent expected to be RENTERS.   Renter Nation hello!

So the ongoing question that will be of keen interest to econo-geeks like me is the key assumptions about continued availability of mortgage financing.

Even if those numbers bear out will they eventually want to become buyers?   If so – and Fannie and Freddie are obliterated – what will fill the void?   However consider my three reasons why Fannie and Freddie will NOT be voted off the island:

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Reason #1.   Will that Dog Hunt?

It’s not at all clear  that is what’s going to happen.   President Obama recently reiterated that he wants to end Fannie and Freddie in favor of a “private” scheme that seems to coincided with a bipartisan proposal.   My immediate snarky responses is….hmmmmm  let’s go sell Iceland and China more residential mortgage-backed bonds.  I’ll bet they will loooove it.

As some of my friends in the south say:  That dog just won’t hunt!   Maybe I am wrong, but it seems to me demand for this product from an investor standpoint would be tepid at best.  Pure assertion on my behalf but it does it appeal to you?   New improved residential mortgage-backed bonds…” No they are great  THIS time….we mean it.  Really, the are!!!”

Reason #2   Fear

Fear of the unknown can be a mighty powerful force to maintain any status quo.   Indeed, according to a CNN article in 2006 only 30 percent of all mortgages were backed by Fannie and Freddie where all government backed mortgages was a stunning 86 percent of all loans originated.    The recovery seems to be real but slooooow.  Are we really going to risk major disruptions to the mortgage market?

Reason #3.  No Clear Political Will in Washington to End the GSE’s

To me, the true canary in the coal mine for the political motive for home-ownership is the mortgage interest tax deduction.   Follow this thread:

  • IF they ever decided to act like adults in Washington and pass some much-needed tax reform
  • IF  that reform happens to scale back or eliminate the mortgage interest tax deduction watch
  • Then watch out Fannie And Freddie your next.

My gut tells me this is not gonna happen.  Further, it seems to me the bank and real estate lobby in Washington combined don’t seem to have a lot to gain by a major change in the status quo.

What do you think?  Are Fannie and Freddie zombies?   To me the risk of changing the system will win out and Fannie and Freddie will be dancing like John Travolta to the tune of the Bee’s Gee’s “Stayin Alive”.

Photo Credit: Nukamari

About Author

Douglas Dowell

Douglas Dowell J.D. is a commercial and multifamily investor. His blog will focus on legally raising private money, risk mitigation with due diligence and management science. He is also an avid student of success principles with a focus on modeling success factors.

13 Comments

  1. I would have to agree. Fannie and Freddie provide a uniform market and I would say as long as congress does not impose imprudent standards then fannie and freddie will be able to operate successfully.
    I do think the American consumer does hold a great deal of responsibility. I never understood why someone would go to the bank and have them tell them how much they could afford. When I bought my first home, I went to the bank as said I would like to be pre-approve for “x” amount knowing that I could have gotten a lot more but I wanted to be able to afford cable in my new house as well ;).
    As for tax reform, specifically addressing the mortgage interest deduction. I believe that there is so much misinformation out there that it would never be a popular choice by the masses of Americans. I have spoke with countless folks who say they keep their mortgage that they could pay off to lower their taxes, especially now since the kids have left the house. This makes little sense. For one they are near the end of their mortgage and are paying little in interest. 2. I highlydoubt that most are far above the standard deduction to even get any benefit from it. 3. The math just doesn’t work. Even if they are in the top tax bracket (lets call it 40% for ease) and they meet or exceed the standard deduction with other deductions, with $10,000 in mortgage interest they pay the bank $10,000 to save $4,000 in taxes. My math tells me it would be much better to pay the $4,000 in taxes and pocket the $6,000. Worst case if they really want the deduction, donate to some charities!! The final reason I feel the mortgage interest deduction will not get touched is the NAR and Banking lobby that you mentioned. The banks benefit greatly from this deduction, probably the most of any group and the NAR caters to the American populous thus fights for this to appear as the good guy.
    Lastly, it should be an interesting next next decade as our population’s dynamics shift. I see the boomers retiring at a rapid pace and anybody that has most of their fingers and wants to work to be able to get a pretty good job. I live in wisconsin and we have quite a bit of manufacturing in my area. The average age of the laborers in most mills is mid-50s. There will be lots of opportunities in the coming years and should enable a strong real estate market at least in my area.

    • Kyle,
      While I agree that keeping a mortgage just to get the deduction is silly, with home loans at such low rates, if you can use the money that would pay off the mortgage to instead invest at a higher rate, it does make sense to keep the mortgage.

  2. Thanks I feel l’ve learned something from your article. I really liked your “voice”, I hope I can learn to interject personality in my writing while imparting valid information as you’ve done here. The demise of Fannie and Freddie are not imminent., you don’t slay sacred cows.

  3. Great article Douglas! I dot think they will disappear either. If they do disappear we are already seeing private sector 5% down loans coming back. Either way I think it will be okay for the real estate investors. If Fannie and Freddie go it will create more renters but might lower prices on sales which I would love. If they stay then house prices will stay relatively stable and there will still be plenty if renters.

  4. I think the reason people didn’t care about the loan terms during the boom was that they assumed the price would double in a few years and they could make a killing, so terms didn’t matter.

    I honestly don’t think it really matters whether Fanny and Freddie keep government backing or not. If they don’t the market will adapt. It may take some time and may be painful, but it will happen.

    I agree that the mortgage interest tax deduction will be kept around largely because of efforts of groups like the NAR. NAR is not interested in what is good for the country, just what is good for its members, which is cheap housing.

    • Douglas Dowell

      Thank you for the comment Adrian,

      I think your right about the perception of unending price doubling. Its ironic because according to Robert Shiller….inflation adjusted the appreciation of housing since 1890…1890…is ZERO. That observation left me gobsmacked.

      I have to agree the lobby factor will probably mean the mortgage interest tax deduction will be left alone.

  5. It’s funny how there were major discussions about winding F&F down RIGHT before all these major settlements with the Justice Department for fraud resulting in big money owed to them.

    If I knew I would end up owing $13B to a company, I’d probably lobby to wind them down as well! Maybe in the light of the fact that big banks were ripping off F&F, some of the “perception” of blame will fall away from the GSE’s!

    I own more than a few thousand shares in FNMA so I’m loving this article 🙂

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