December 3, 2013

Bove: Fannie, Freddie Shutdown Would Have ‘Colossal’ Fallout

U.S. mortgage market and homeownership could be radically more limited if these entities are phased out, bank expert says

Some experts, like Nouriel Roubini, are debating how hot the housing markets are in some countries, like China, and warning of another real estate bubble. 

But to banking expert Dick Bove of Rafferty Capital Markets, there’s a different doomsday scenario: The government’s winding down of mortgage institutions Fannie Mae and Freddie Mac, set for 2018, which would dramatically curtail homeownership in the United States and cause serious economic repercussions in the process.

Bove wrote recently about the “colossal” fallout from the end of Fannie and Freddie, noting that “no bank would be willing to assume the risk” of 20- or 30-year fixed-rate mortgages without them, according to a Yahoo Finance report today.

These entities, along with Ginnie Mae, issue the bulk of mortgage-backed securities, which bring liquidity to the market. Fannie and Freddie have been run by a conservatorship arrangement since late 2008; during the financial crisis they required a combined government bailout of nearly $190 billion, which they have nearly paid back.

If these entities go away, homebuyers “will no longer have things like 20-year and 30-year mortgages, because banks are not going to put that type of mortgage on their balance sheets. And we won't have fixed-rate mortgages," Bove explains.

Banks won’t have the wherewithal to provide these long-term mortgages without the institutions backing them up, the analyst says.

"I've called a number of very large banks — the largest issuers of mortgages in the United States — and asked them, 'If there was no Fannie and Freddie, what would be the typical mortgage in the United States?' And, the answer is a 10- to 15-year adjustable rate mortgage," Bove stressed.

Without these types of mortgages, home-equity loans and their associated consumer spending are likely to dry up, too.

"If your mortgage cannot be a 30-year fixed-rate mortgage — [if] it's a 10-year adjustable rate mortgage — then the monthly cost of owning a house goes up dramatically," Bove noted. "And if the monthly cost of owning a house goes up dramatically, the price of the house goes down. There is no equity buildup in order to have home equity loans in order to buy cars, boats, what have you. So it has an impact on the overall economy, not just Fannie Mae and Freddie Mac."

Other Scenarios

Fairholme Capital Management has offered some $52 billion to the two entities, according to TheStreet. The deal would liquidate Fannie and Freddie at a profit to the U.S. Treasury, Fairholme says, and give the private market the role of supporting new mortgages issued starting next year and would involve the creation of two private insurers.

The government rejected the latest Fairholme proposal in late November.

Several years ago, Warren Buffett said that the structure and terms of the government's conservatorship of Fannie and Freddie resemble what he looks for when investing in troubled firms — producing some speculation recently that Berkshire Hathaway might consider investing in the entitites.

Some observers, though, seem to think Congress will eventually restore the agencies to their original forms in order to promote homeownership. "It is a reasonable but extremely high-risk speculation," noted Bove late last month.

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Check out Buffett’s Bank Bets Are on the Money: Report on ThinkAdvisor.

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