Residential Magazine

The Road Ahead for Fannie and Freddie

A court ruling could tip the scales in competing proposals for the future of the GSEs

By Thomas Lemke

One issue facing President Joe Biden’s administration is the need to address the long-standing status of the government-sponsored enterprises (GSEs) — Fannie Mae and Freddie Mac — that are in government-mandated conservatorship. Reform of the GSEs is the last major piece of unfinished business from the 2007 housing crisis.

Since the two companies dominate the housing market and are important to U.S. economic health, their reform is critical to both. Different approaches to reform have been set out to resolve this issue, and a case pending before the U.S. Supreme Court likely will determine which approach goes forward.

The GSEs generally provide liquidity and stability to the U.S. mortgage market, primarily by purchasing home loans from private lenders, pooling these loans into mortgage-backed securities and selling the securities to private investors. By purchasing loans, the GSEs provide additional funds that lenders can then use to make new mortgages.

By bundling loans into securities backed by the GSEs’ credit guarantees (for which the GSEs earn guarantee fees), the agencies attract investors who otherwise might not have invested in mortgages — thereby expanding the pool of funds available to make home loans. A critical part of the public mission of the GSEs is to support low- and moderate-income housing, especially in underserved areas.

The housing-market collapse of 2007 pushed the GSEs to the brink of ruin. Their significant losses necessitated a taxpayer bailout and in 2008 they were placed in conservatorship under the strict governmental control of the Federal Housing Finance Agency (FHFA). As a result, the implicit governmental guarantee previously enjoyed by the GSEs and their mortgage-backed securities became an explicit one.

Conservatorship has stabilized the GSEs and the housing-finance system for now. There is widespread belief, however, that this is not a sustainable long-term structure. Resolving the conservatorships is complicated, and while no general consensus has emerged, Republicans and Democrats have offered different approaches to address the needed reforms.

Republican plan

The Republican proposal is set forth primarily in a housing-reform plan drafted by the U.S. Department of the Treasury in September 2019 on behalf of the Trump administration. It includes nearly 50 recommended legislative and administrative reforms designed to limited the federal government’s role in the housing-finance system, enhance taxpayer protections against future bailouts and promote private-sector competition.

Specifically, the plan recommends that existing government support of the housing-finance market be explicitly defined, tailored and paid for, and that the GSEs’ conservatorships should come to an end, subject to certain preconditions. To enhance taxpayer protections against future bailouts, the plan seeks to ensure that the GSEs are appropriately capitalized and that shareholders and unsecured creditors, rather than taxpayers, bear any losses.

Further, the plan would allow the FHFA director to charter new mortgage market guarantors to compete with the GSEs. To help reduce their dominance and attract private entities into the market, the plan would require the GSEs to exit some profitable but noncore business channels, such as cash-out refinancings, investor loans, vacation-home loans and higher principal-balance loans. The plan expects, but does not necessarily guarantee, that the 30-year fixed-rate mortgage will remain widely available in a more market-oriented housing-finance system.

To end the conservatorships, the GSEs must build their capital reserves to levels commensurate with safety and soundness. To achieve this goal, the plan seeks to impose bank-like capital requirements on the GSEs, similar to those imposed on large banks, in the belief that this will level the playing field for other (mostly bank) participants in the housing-finance market. The FHFA is moving ahead with a rule for recapitalizing the GSEs (which was reproposed in May 2020). The plan also seeks to ensure that the government is properly compensated for any explicit or implicit support it provides to the GSEs or the secondary housing-finance market.

The FHFA has a single director appointed by the president. The current director, Mark Calabria, is moving forward with various aspects of the plan and expects the GSEs to be out of conservatorship by the end of his term in 2024. A constitutional challenge to the agency’s leadership structure, however, is currently before the Supreme Court and will play the determinative role in how reform goes forward.

Democratic plan

Democrats view GSE reform from a different perspective. In recent years, their ideas have focused on reforming the existing agencies rather than the more radical approaches of winding them down, replacing them with something unproven or substantially changing the structure of the mortgage finance market. Small lenders, in particular, support such an approach, as does the National Association of Realtors.

The most prominent of these ideas is commonly referred to as the “utility model.” Championed by Sen. Sherrod Brown, D-Ohio, ranking member of the Senate banking committee, this approach would reform the GSEs by regulating them like public utilities, such as a local electric or water company, subject to rate-of-return regulations.

After being reformed and recapitalized, the plan calls for the GSEs to be released from conservatorship. The GSEs would be required to focus on performing their existing core role of issuing mortgage-backed securities and, in particular, supporting mortgages for low- to moderate income households. This would ensure the continued availability of the 30-year fixed-rate mortgage. This approach also would preserve the current high degree of standardization of mortgages (particularly for fixed-rate loans) and associated market structures that many believe are worth preserving. Most of all, this approach would avoid a multiyear disruption while transitioning to a new system.

Under the utility model, the major change to GSE operations calls for the FHFA, in addition to being a safety-and-soundness regulator, to set pricing for GSE guarantees and other key terms of service. Through its oversight, the FHFA would be responsible for ensuring that the GSEs do not return to behavior counter to good public policy or that might require another taxpayer bailout.

The utility approach has broad housing-finance industry support and could be implemented with a low risk of disruption or unintended consequences that negate the best of intentions. Don Layton of the Joint Center for Housing Studies of Harvard University, a former Freddie Mac CEO, has stated that the utility model limits risk while continuing decades of Democratic Party support for the GSEs in expanding homeownership and making it affordable.

Due to unusual circumstances, it is the Supreme Court that will play the key role in determining which path GSE reform will follow.

Court role

Both political parties have set forth GSE-reform plans that are consistent with the parties’ traditional perspectives on issues. Ordinarily, the election of a Democratic president would mean that the FHFA would seek to implement the Democratic plan. In this case, however, due to unusual circumstances, it is the Supreme Court that will play the key role in determining which path GSE reform will follow.

Lax oversight of the GSEs was viewed as a key contributing factor to the 2007 housing crisis. As a result, Congress adopted a requirement that the FHFA director could be fired by the president only for good cause. A challenge to this structure is currently before the Supreme Court in the case of Collins v. Mnuchin, in which the key issue is whether the FHFA’s single-director structure violates the separation of powers and is an unconstitutional infringement on the powers of the president to remove executive officials at will.

In many ways, the Collins case mirrors one involving the Consumer Financial Protection Bureau (CFPB) that the Supreme Court ruled on in June 2020. In Seila Law LLC v. CFPB, the court held that the similar single-director structure at the federal agency violated the separation-of-powers doctrine because it prohibited the president from removing the CFPB director at will.

The court concluded that the CFPB’s single-director configuration is incompatible with the structure of the Constitution, which scrupulously avoids concentrating power with any single individual, except the president. In reliance on the Seila case, the plaintiff in the Collins case argues that the similar single-director structure at the FHFA should be held as unconstitutional.

Others argue, however, that the FHFA’s structure is materially different from that of the CFPB in two primary ways that support the lawfulness of the FHFA’s structure. First, the FHFA does not wield regulatory or enforcement authority comparable to the CFPB, whose director had the power to directly affect the lives of millions of citizens. Rather, the FHFA is focused solely on the regulation of the GSEs.

Second, the FHFA’s authority to regulate Fannie and Freddie is limited. Unlike the CFPB, the FHFA has no authority to regulate purely private entities. It only regulates entities like the GSEs that Congress creates, subsidizes and regulates. As a result, the defendants argue, Congress can lawfully choose to impose a for-cause restriction on the president’s power to remove the FHFA director.

Oral arguments in Collins v. Mnuchin were heard this past December and a decision was expected this year. Until then, the ultimate path of GSE reform will remain in limbo. ●


  • Thomas Lemke

    Thomas P. Lemke is a retired financial-services executive who last served as general counsel and head of governance for a major firm. He also is the co-author of a number of financial-services publications, including “Mortgage-Backed Securities” (Thomson Reuters, 2020). Reach Lemke at

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