On Dec. 9, 2020, the U.S. Supreme Court is scheduled to hear arguments in Collins v. Mnuchin, a lawsuit involving the government-sponsored enterprises (GSEs) and their regulator, the Federal Housing Finance Agency. Changes to the GSEs, Fannie Mae and Freddie Mac, could be coming down the pike sooner than many observers expected, so what could the Supreme Court case mean for the nation’s housing-finance market?
First, it’s important to understand what Collins v. Mnuchin is about. The federal government is arguing that by instituting a so-called net worth sweep — which allows it to place all of Fannie Mae’s and Freddie Mac’s profits into the U.S. Treasury — it saved the enterprises from a vicious cycle of borrowing more money and paying out more dividends.
The government also claims it has maintained the safeness and soundness of the GSEs while rescuing them from insolvency. Increasingly, however, there is debate that Fannie and Freddie weren’t as insolvent as it appeared during the housing crisis. Instead, it’s looking like the government seized their profits to bail out the nation’s largest banks, which were arguably the main cause of the housing crisis in the late 2000s.
The plaintiffs are arguing that the government hasn’t been protecting the GSEs and that, as their conservator, it doesn’t have the right to run them in such a way that they are harmed in the process. At the core of the issue are the dividends that were paid to the GSEs’ preferred shareholders, which the plaintiffs say the government had no right to take. Although much of the direct impact of the Collins case will be felt by Fannie’s and Freddie’s investors, any final rulings also could send a ripple effect through the housing-finance industry.
History shows us that the health of the GSEs has major implications for the housing-finance industry as a whole. Some industry pundits have argued that if Joe Biden wins the presidential election (Biden was the projected winner, but results had yet to be certified at press time), this would put an immediate halt to GSE-reform efforts.
Odeon Capital Group analyst Dick Bove, however, pointed out this past September that no matter who is in the White House, they will need a strong economy, and a key part of that is a strong housing market. It could be argued that Fannie Mae and Freddie Mac must be taken out of conservatorship to strengthen the housing-finance market, even though it has been doing quite well despite the COVID-19 pandemic.
The demographics of the housing market are strong. The population of working-age adults (especially those under 45 years old) is climbing, which is a good sign for homeownership. U.S. money supply is growing year over year by nearly 25%, which is the highest rate since at least 1980, when the landmark Monetary Control Act was passed. Interest rates remain near record lows, while the pandemic is causing more households to move out of major cities and is increasing the demand for larger homes to meet remote-working needs.
Bove also argues that for the housing-finance market to build on these promising trends, it needs Fannie Mae and Freddie Mac to be private entities that issue mortgage-backed securities with “quasi government guarantees” for 30-year mortgages. He points out that the government doesn’t have the ability to fund housing growth by capturing trillions of dollars but the private sector does.
By removing the GSEs from conservatorship, the mortgage industry would be able to tap private coffers to fuel growth in housing, which in turn should drive an overall economic recovery. To be able to tap private funds, Fannie and Freddie must be released from conservatorship and arranged in a manner that gave them a strong position prior to the subprime mortgage crisis.
The plaintiffs in the Collins case are arguing that the GSEs were not insolvent at the time they entered conservatorship. Further, Bove notes that no major housing innovations have occurred in the past 12 years, which is how long Fannie and Freddie have been in conservatorship. Without innovations, the mortgage industry can’t return to the growth it once enjoyed.
If the Collins case results in a removal of the net worth sweep…it could pave the way for the GSEs to be released from their conservatorships.
Many would argue that the big banks — not the GSEs — were the real cause of the housing crisis. For this reason, it makes no sense to keep the GSEs from the position they were in before the crisis occurred.
If the Collins case results in a removal of the net worth sweep, as many believe it will, it could pave the way for the GSEs to be released from their conservatorships. This would be a good thing for the mortgage industry, which needs the 30-year mortgage because it enables more people to own homes.
It’s impractical for big banks to hold mortgages on their books for 30 years, and there is even less incentive when interest rates are so low, which is why they sell loans to the GSEs. When the enterprises are restored to their previous positions as private entities, the housing-finance industry will be free to grow through the support of private money rather than being held back by government limitations. ●