Mortgages as we know them in the US are going away in the next four years, warns Dick Bove, vice president of research at Rafferty Capital.
Mortgages as we know them are going away in the next four years, warns Dick Bove, vice president of research at Rafferty Capital. Bove, one of the most widely-respected banking analysts in the world, is certain that will have devastating consequences for housing and the rest of the American economy.
The removal of the two most important players in American mortgages – the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") – threatens the very foundation of the American economy, according to Bove.
These two government-sponsored entities – along with the smaller Government National Mortgage Association ("Ginnie Mae", a government corporation that broke off from Fannie Mae) – issued 98% of the $1.4 trillion in mortgage-backed securities in the United States so far in 2013. These securities are sold in order to add liquidity to the mortgage market, thereby making funds available to borrowers.
(Watch: Pending home sales fall again)
But, since September 2008, both Fannie Mae and Freddie Mac have been under a conservatorship run by the Federal Housing Finance Agency (FHFA). During the financial crisis, both faced billions of dollars in losses and went to the government for a bailout. Fannie Mae received $116 billion while Freddie Mac took $71 billion. The two have nearly paid back everything they took from Uncle Sam and the government is expected to see profits beginning sometime in 2014.
The bailouts also came at a steep price for Fannie Mae and Freddie Mac – they will be phased out by 2018 under a plan developed by the Obama administration (see the Treasury Department's white paper: "Reforming America's Housing Finance Market" - .pdf). Congressional Republicans and Democrats also want to see an end to Fannie Mae and Freddie Mac, though they don't agree on what should be done to replace them.
For Bove, the end of Fannie Mae and Freddie Mac will radically shake up the kind of mortgages most Americans will get.
"If Fannie and Freddie go away, what then happens to the mortgage markets?" asks Bove. "The answer to that question is that we 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."
Unlike the rest of the developed world, most homes in the US are bought with long-term fixed mortgages. Prior to the Great Depression, mortgages often required 50% down with interest only payments for five years with the principal due in full after those five years were up. To stabilize the mortgage market during that economic crisis, the Federal Housing Administration (FHA) helped develop the 30-year fully amortizing fixed-rate mortgage which it would insure. Fannie Mae's original role was to package FHA-insured loans from individual lenders and sell them to the markets; it is now also the largest purchaser and seller of residential mortgages.
Bove says the banks he spoke with won't be able to provide 30-year mortgages in large quantities without Fannie Mae and Freddie Mac in the markets. "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."
The end of Fannie Mae and Freddie Mac is a major sea-change in how the government views affordable housing, according to Bove.
"It is no longer the goal of the United States government that every household should have its own home," say Bove. "In my view, that's a call for a return of public housing and all of the ills that went with public housing."
But, it's not just affordable housing that will go away with Fannie Mae and Freddie Mac, says Bove. It's also home equity and the added consumer spending that goes along with it.
"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," says Bove. "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."
To see the rest of Bove's take on what the end of Fannie Mae and Freddie Mac means for mortgages in the United States, watch the video above.
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