Must-know: Mortgage reform and the future of housing finance (Part 3 of 5)
The government charges guarantee fees for the cost of insuring aloan
Most government loans end up being securitized. If the borrower defaults on the loan, the investor doesn’t bear the loss—the government does. This allows mortgage rates to be lower than they otherwise would. The government charges what is known as a “guarantee fee” (or “G-fee”), which is its compensation for taking the default risk on a mortgage and for running the government loan program.
One lesson that came out of the financial crisis was that the government was undercharging for this insurance, which became apparent when the funds that provide insurance became insolvent. The systemic undercharging for insurance ended up being a subsidy, and if there’s one thing the U.S. government does more than any other country, it’s subsidize residential real estate. Most Americans are fine with this and would be aghast to discover that the 30-year fixed-rate mortgage is more or less an American phenomenon. Government subsidies make this mortgage possible.
The government is in the process of price discovery
Given that G-fees were too low prior to the crisis, the government is now in the process of trying to figure out the correct level. While historical simulations are useful, the most relevant information out there is more market-based—at what level does private capital step in with a similar insurance product? That’s the process of price discovery. The government wants to reduce the state’s footprint in the mortgage market.
Balancing costs to taxpayers versus housing affordability
The first order of business for Mel Watt was to suspend the latest G-fee increase from Ed DeMarco. Housing advocates were worried that mortgages were becoming too expensive. This is something to watch, because there is a large ideological investment on both sides of the political spectrum. The right wants to reduce the government’s footprint and housing subsidies, while the left wants to increase subsidies and affordable housing mandates. Any housing reform will undoubtedly affect agency mortgage REITs like Annaly Capital (NLY), American Capital Agency (AGNC). MFA Financial (MFA), Hatteras (HTS), and Capstead (CMO).
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