Fannie Mae Is Back from the Dead
Since the election of President Trump, the stock market has been on a roll—up around 10%. You might be surprised, however, to learn that the biggest post-election winner has been the Federal National Mortgage Association, a.k.a. Fannie Mae.
Yes, this is the same Fannie Mae that was knee-deep in the housing crisis when the U.S. Treasury Department had to take over the mortgage-backed securities enterprise and place it into conservatorship in September 2008.
You may ask: How can a company taken over by the government still be trading on an exchange or market? The reason: the U.S. took over only 80% of Fannie Mae
The thinking was, if the U.S. Treasury didn’t own all of Fannie Mae, it did not have to add the company’s trillions of dollars of debt to the government’s already expanding debt, thus giving the government time to figure out what to do with the behemoth of an enterprise so intertwined with the housing market.
Fannie Mae and the Mortgage Market
The Federal National Mortgage Association was created in 1938 as part of the New Deal in response to the housing disaster caused by the Great Depression, when almost a quarter of all mortgages were in default. Fannie Mae’s mission was to create a secondary market for mortgages by buying mortgages from banks, thus freeing up those banks to make new mortgages.
Over the years Fannie Mae went through many incarnations, eventually becoming a “blue chip” public company traded on the New York Stock Exchange.[i] The association’s main roles were to buy, securitize and insure mortgages.
Before the 2008 housing crisis, critics of Fannie Mae pointed out that the dichotomy of a public company providing implicit government guarantees creates [ii]a moral hazard for the government by forcing it to guaranty risks it was not underwriting.
The guarantee was implicit, because the U.S. Treasury never said it was guaranteeing Fannie Mae’s promises. Most investors thought otherwise, believing that if push came to shove the government would end up doing what it did during the 2008 crisis: to guarantee the holders of Fannie Mae’s securities and commitments.
The Obama Plan
The Obama administration had promised to eliminate Fannie Mae and create space for a private market to securitize and guarantee mortgages, but never fulfilled this commitment. Instead, after the housing market recovered, Fannie Mae began to make money, and the administration started to use the company’s profits to reduce the government’s budget deficit.[iii] This failure has left an important part of our economy in limbo and without a long-term solution.
The Trump Plan?
Many investors believe President-elect Trump will bring Fannie Mae back from the dead. One of those investors is John Paulson, who made billions betting against the sub-prime mortgage market. He was also an early supporter of now President-elect Trump.
They predict he will sell the government-owned 80% back to the public and in theory make lots of money for the government and the 20% who already own the stock.
If this happens, no one is sure what a new Fannie Mae might look like. In fact, most Republican legislators are against bringing it back. As they were never happy with the previous public/private nature.
A bigger question is: Does the housing market need a public/private guarantee? Some say yes, claiming that without such a guarantee banks would hesitate to provide 30-year mortgages, and the cost of borrowing would go up for everyone. Others fear a repeat of the 2008 crisis, in the form of a public/private alliance creating a moral hazard that would reward the few by privatizing gains and publicizing losses.[iv]
[i] Cornwell, Ted, “ From Blue Chips to Penny Stocks,” National Mortgage News, Sept. 15, 2008 https://www.nationalmortgagenews.com/nmn_issues/32_49/-452272-1.html
[ii] Bethany McLean, Shaky Ground The Strange Saga of the U.S. Mortgage Giants (Kindle Version)
[iii] Bethany McLean, Shaky Ground The Strange Saga of the U.S. Mortgage Giants (Kindle Version)
[iv] Light, Joe, Paulson’s Big Long: A Bet on Trump Yields Power and Profit, November 21, 2016 https://www.bloomberg.com/news/articles/2016-11-21/paulson-s-big-long-a-bet-on-trump-yields-power-and-profit
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.