Fannie-Freddie Capital Rule Seen Harming Less-Wealthy Borrowers

(Bloomberg) -- A top regulator's plan for boosting Fannie Mae and Freddie Mac's ability to withstand losses could mean higher costs for many mortgage borrowers, with the burden falling most heavily on those with less wealth and lower incomes, according to economists and housing-finance experts.

The 424-page rule released for comment by the Federal Housing Finance Agency last month would dramatically raise the amount of capital the two mortgage-finance giants must hold and likely increase fees they charge for guaranteeing loans, which would hit borrowers in the form of higher interest rates.

FHFA Director Mark Calabria's proposal highlights the fine line his independent agency and the U.S. Treasury Department must walk to achieve their stated goal of freeing Fannie and Freddie from the government's grip. To claim success, they will likely have to pull off a juggling act of keeping down borrowers' costs, protecting taxpayers, appeasing mortgage-bond holders and enticing stock investors needed to re-capitalize the companies.

Mortgage rates would have to rise between 0.15 and 0.2 percentage point on average to meet Calabria's proposed capital requirements, all else being equal, according to Bob Ryan, who was a senior FHFA adviser until mid-2019 and now consults for firms in the mortgage industry.

The higher interest rates could weigh most heavily on borrowers with lower credit scores and smaller down payments, said Moody's Analytics chief economist Mark Zandi. In a stressed economic environment, those borrowers might see rates as much as half a percentage point higher than they otherwise would, Zandi said. That would mean, for example, that someone with a $200,000, 30-year mortgage would pay an additional $58 a month if their interest rate was 4.5% rather than 4%.

“It's confusing to me,” Zandi said of the proposed rule. “I'm not really sure who benefits from this. I'm not even sure it helps their goal of privatizing” Fannie and Freddie.

FHFA spokesman Raphael Williams said in an email that it is “far too early to speculate” on the rule's impact on Fannie and Freddie's guarantee fees. He said that more-stringent capital requirements in other areas of the financial system, such as for banks and private mortgage insurers, hadn't significantly raised borrowing costs or reduced credit access.

QuickTake: Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac have been under U.S. control since the 2008 financial crisis. The two companies, which have returned to profitability while in federal conservatorship, buy loans from lenders, wrap them into securities and make guarantees to investors in case the loans default. They charge lenders a fee for those guarantees, which flows to borrowers in mortgage rates.

Although they hold little capital today, Fannie and Freddie set their guarantee fees based on assumed capital requirements and the return expectations that investors would have if they were private companies. If either capital requirements or return demands increase, fees also rise.

Calabria's proposal would require Fannie and Freddie to hold about $240 billion in capital, based on their assets in September 2019. That's more than 70% higher than the amount that would have been required by a 2018 proposal by former FHFA Director Mel Watt. Fannie and Freddie currently set their fees to guarantee mortgages roughly in line with the 2018 proposal, even though it was never finalized.

When the new rule was released last month, a senior FHFA official said that if Fannie and Freddie held the proposed levels of capital in 2008, they would have been able to survive the crisis without a bailout.

Raising Capital

As they move toward releasing the companies, FHFA officials have said Fannie and Freddie could attempt to raise capital from private investors as soon as next year. The agency in February hired investment bank Houlihan Lokey Inc. to help with that effort, and the two companies said last month that they would seek their own advisers.

Those firms and conversations with private investors will give the companies and the FHFA a better understanding of what sorts of returns the investors would require to participate in potential public offerings.

The prospect of higher capital requirements complicates the path forward for Fannie and Freddie. Fee increases could push more lending to other companies and reduce their market share, Zandi said. Banks could choose to hold loans on their own balance sheets rather than sell to the mortgage giants. And more borrowers might also get loans backed by the Federal Housing Administration, a government agency that targets lower-wealth borrowers. All of those factors could make the companies less attractive to private shareholders.

Some affordable housing advocates have argued that Fannie and Freddie should have their returns regulated like those of public utilities, which could mitigate the increased capital requirements' impact on mortgage rates.

Mike Calhoun, president of the Center for Responsible Lending, said that whether or not the FHFA decides to regulate Fannie's and Freddie's returns will have the biggest impact on consumers.

The agency's proposal “makes efforts to spread costs. But nonetheless more capital is more costs, and the $64,000 question is the rate of return on that capital,” Calhoun said.

The FHFA plans to accept public comments on the proposal for 60 days after it's published in the Federal Register, which itself could take a few more weeks. The rule could be finalized by the end of the year.