"As-is" release of GSEs would be fraught with pain

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For all of you who hoped for a peaceful, uneventful year in 2025 with the re-election of President Donald Trump, think again. Over the past four years, mortgage lenders had to contend with progressive policy nonsense, punitive fines from the Consumer Financial Protection Bureau, and an abject state of incompetence among many government officials. 

Now we face a different set of aspirations, but not necessarily more reasonable policies in practical terms. Probably top of President Trump's list when it comes to things impacting the mortgage sector is lower interest rates, something that the president-elect has spoken about over the past year. 

President Trump would like to see the Federal Open Market Committee lower short term interest rates in the coming year. Yet while Trump is expecting falling interest rates, the Treasury under nominee Scott Bessent is expected to reduce issuance of T-bills and increase issuance of term debt. Look for more volatility on the long end of the Treasury yield curve. 

In January of this year, Bessent warned: "Over a medium-term horizon, we believe [high bill issuance] is a risky strategy, and it comes with significant costs. In addition to a higher interest expense, concentrating issuance in short tenors exposes the Treasury to greater volatility via refinancing risks and creates the potential for a financial accident."  

Speaking of financial accidents, the overnight fed funds market spiked at the end of September. The folks at the Fed don't seem to know why. There is a plentitude of cash in the short-term money markets, at least according to the Fed's model. As the Fed runs its reverse repo facility (think t-bills) down to zero, bank reserves should be increasing. Yet the short-term markets spiked big at the end of Q3. Is the Fed near the "floor" in terms of funding even though the model says otherwise? 

It sounds like the yield curve is going to continue to normalize in 2025, with short-term rates falling and long-term market yields and mortgage rates basically staying where they are or moving higher. If you think this sounds like a recipe for increased interest rate volatility… you're right. 

Bond market volatility could spill over into financial stocks, which have been on a post-election tear of late. Lower short-term rates will boost production profits for many lenders, but may not help the equity markets.

"Stocks are at greater downside risk from speculative excess that is likely to be supercharged if further bank deregulation is applied by the incoming Trump administration," writes Simon White of Bloomberg. "That could be enough to tip stocks over the edge… Stocks have been buoyed by excess liquidity this cycle."

Mortgage rate unpredictability will be the driving factor for the market in 2025, likely leading to short bursts of refinance activity as the industry experienced in September, the December Fannie Mae economic forecast said.

"From an affordability perspective, we think 2025 will look a lot like 2024, with mortgage rates above 6%, home price growth easing from recent highs but staying positive, and supply remaining below pre-pandemic levels," said Mark Palim, Fannie Mae chief economist.

One new initiative that could cause significant volatility in the mortgage market is the prospect of Fannie Mae and Freddie Mac finally emerging from conservatorship after 16 years of government control. As we noted in a commentary appropriately entitled "Kamikaze GSE Release? Oh Yeah…" release is likely to occur "as is," without enabling legislation.

The Mortgage Bankers Association wants to see new legislation to facilitate release of the GSEs, but our informal survey of DC housing mavens and Wall Street credit folk suggests that is not going to happen, even with GOP control of Congress. But the quick route to release may destabilize the $7 trillion market for conventional loans. We wrote:

"Once the GSEs exit government control, however, the issuers will for the first time be treated as private companies and, more importantly, be rated by Moody's et al as finance companies instead of sovereigns. No amount of private capital replaces the full faith and credit of the United States. Only a sovereign credit earns a "AAA" rating from Moody's."

The quick way to release the GSEs means that the U.S. government will no longer guarantee the conventional mortgage-backed securities. When the GSEs are downgraded by Moody's et al prior to release, all of the MBS and unsecured debt that depends upon these issuer ratings will also be downgraded. 

As one veteran GSE observer opined to NMN, without the preferred stock purchase agreements with the Treasury, "the GSEs would last about as long as the cardboard ships do in my kids' bathtub."

One of the big questions is whether the loan and MBS guaranteed by the "private" GSEs will be eligible for the crucial to-be-announced or "TBA" market for hedging interest rates. In the world of TBA, warehouse loans and gestation repos, at a minimum release means a growing distinction between government and agency collateral. 

Upon release "as is," GSE paper will be 20% risk weight for Basel III and no longer eligible for purchase by the Fed.  The idea of conventional loans and MBS not being explicitly guaranteed by the US government is going to come as a rude shock for many mortgage market participants. Some of the largest financial institutions on Wall Street operate under the false assumption of legislation to preserve a federal credit wrap on agency MBS. 

JPMorgan research wrote on 26 November: "An explicit, paid for guarantee on the MBS is the only logically consistent course of action, for numerous reasons—but there's no law preventing a return to a murky 'implicit guarantee' on nominally private Enterprises."

Yes, that's right, we could downgrade $8 trillion in GSE residential and multifamily MBS and hundreds of billions in corporate debt in order to placate a small group of private investors and hedge funds. The public good be damned. When the Treasury announces the release of the GSEs, Moody's may first take the opportunity to finally downgrade the credit rating of the US, which is on a negative outlook already.  

After more than a decade under government control, most people who work in mortgage finance understand that the GSEs operate best as government agencies. The tab owed to the taxpayer by the enterprises represented in the total "liquidation preference" for the Treasury is over $350 billion and growing.

Releasing the GSEs "as is" without legislation is possible, but very high risk for the shareholders and the implicit public interest. Sam Sutton of Politico reported last month that Kevin Warsh, a former Federal Reserve governor and George W. Bush aide, isn't sure privatizing Fannie Mae and Freddie Mac would be worth the fight.

"Congress, I think, keeps telling us, Democrats and Republicans, presidents of both parties, that these are effectively backed by the United States government," Warsh said at a conference hosted by the Atlanta Fed in May. "Let's just own that." 

Warsh continued: "This muddled middle with a, 'Yeah, they're private until something bad happens, and then what we're going to do in our wisdom is socialize the losses and let the profits be privatized in good times.' This strikes me as the worst way for an American economy that needs durable, sustainable growth and credibility of the world to proceed from here on out."