Freddie Mac – a federal government-controlled mortgage lending giant – wants to expand its presence in the bond market by starting to buy second mortgages. Taxpayers should be concerned and regulators skeptical. The proposal, which will be tested in a pilot program soon, is more than the usual Washington power grab, it’s an example of government creating a problem that taxpayers will be forced to pay for.
Freddie Mac is a government-sponsored enterprise (GSE), which, along with its big sister Fannie Mae, dominates the mortgage market. Its mission is to increase access to credit and help make housing more affordable, which it does well with the help of the private sector. Together, they bundle mortgages into bonds and sell them on the open market, a risk-reducing process called securitization.
At the end of last year, there were $14 trillion in outstanding mortgages in the U.S. GSEs bought and repackaged roughly half that amount. Freddie Mac wants to increase its presence in the market by securitizing single-family, closed end second mortgages in addition to the first mortgages it already purchases.
There’s no reason to make that change. Private sources are doing an excellent job managing second mortgages, and they are already affordable and attainable. While the risks associated with second liens are relatively higher than the risks associated with primary mortgages, market participants have been utilizing existing channels and to appropriately price for that risk in the capital markets. Indeed, the number of securitized second mortgages has been rising thanks to increased private investment.
If Freddie Mac and, inevitably, Fannie Mae begin buying second mortgages, the private sector would not be able to compete. Freddie and Fannie, which are backed by taxpayers, have a significant competitive edge over private investors. Banks and private investors would be squeezed out of the market by the massive GSEs, which—due to their size and scale--may not appropriately price for the underlying risk.
If Freddie were to enter the market, homeowners would see taking out a second mortgage as a government subsidized way to finance home improvements and would be more reluctant to sell their homes to trade up to larger properties with more amenities. The already-tight housing market would get even tighter because even fewer homes would be available for sale. Lower inventory would boost prices, which already are too high for many Americans hoping to purchase their first homes. Freddie Mac would be undermining its own goal of making home ownership attainable and affordable for more American families.
In addition to edging out private investment and driving up housing prices, this move would increase taxpayer risks. The more second mortgages Freddie buys, the greater the risk of default that it – and therefore taxpayers – takes on. Should the housing market decline as it did in 2008, taxpayers would be on the hook for potentially huge losses, a scenario that nearly took down the global financial system when it occurred 16 years ago.
Because of the market meltdown back then, Freddie and Fannie are controlled by the Federal Housing Finance Agency, whose job is to conserve and preserve the GSEs’ assets. The FHFA should reject Freddie Mac’s proposal because it runs contrary to its own purpose and the mission of the GSEs.
The FHFA has approved a limited pilot program to test the impact of Freddie Mac purchasing second mortgages. But even on a limited scale, the plan unnecessarily encroaches into a market that has been operating effectively without government involvement. The more prudent course would be to not allow Freddie and Fannie to buy closed-end second mortgages at all.
Indeed, if the Freddie Mac pilot were to grow, it would undermine Freddie Mac’s mission, increase home prices, and vastly and unwisely expand the GSEs’ presence in the U.S. housing finance system at the expense of a thriving private business that has been serving the public well. American taxpayers, who backstop Freddie Mac’s activities, shouldn’t be forced to shoulder the added risk.
