The Psychology Behind the Recovery

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60 | Th e M Rep o RT O r i g i nat i O n s e r v i c i n g a na ly t i c s s e c O n da r y m a r k e t SECONDARY MARKET the latest the Fate of Fannie and Freddie The Gilbert Garcia Group's Ceo lays out the different paths ahead c ongress chartered Fan- nie Mae in 1938 as part of the New Deal and Freddie Mac in 1970. Although they were chartered by the federal government, the cor- porations were owned by private shareholders for the purpose of making homeownership affordable for lower- and middle-class and other underserved Americans. In theory, GSEs purchase mortgages from lenders, guar- antee them, and package them into mortgage-backed securities, which they either keep as invest- ments or sell to institutional investors. Lenders are able to increase liquidity and lending potential by selling these loans to the GSEs, which in turn should increase availability of credit. In practice, they have domi- nated the mortgage finance market, thus promoting home- ownership. This domination is attributed to the ability of the GSEs to buy mortgages by borrowing at below-market rates based on the illusion of a government guarantee. In the 1990s, they implemented housing initiatives encourag- ing lenders to offer low-down- payment mortgages to low- and middle-income families and to loosen underwriting guidelines, both factors that contributed to the housing bubble. In the early 2000s, Wall Street increased quantity of loans—of- ten non-GSE, riskier loans that were securitized, another factor contributing to the bubble. By 2005, the GSEs, which were losing market share, loosened underwriting guidelines, taking on more risk without an increase in capital reserves. As the bubble began bursting in 2008, some in Congress want- ed the GSEs to take on more risk, but U.S. Treasury officials, alarmed by continued devalua- tion of GSE loan portfolios, GSE weak capital reserves, potential investor sell-off, and impact on global markets—persuaded the GSEs to consent to conservator- ship in September 2008. The Housing and Economic Recovery Act (HERA), enacted in July 2008, created the Federal Housing Finance Agency (FHFA), the GSEs' conservator since 2008. Fannie and Freddie con- tinue to dominate the secondary mortgage market: They currently have more than $5.6 trillion in obligations outstanding, an amount nearly 40 percent the size of the entire U.S. economy, and they owned or guaranteed about 61 percent of all new residential mortgage loans in the United States in 2012. Contrasted with private mortgage origina- tion, only $5.2 billion in resi- dential mortgage-backed securi- ties have been issued without government support in the same time period. importance of gse reform F reddie and Fannie received a $188 billion bailout from Treasury and had paid $146 billion back by September 2013, with two-thirds paid back this year. They continue to be profit- able, while having increased lender fees and tightened underwriting guidelines, and, along with the Federal Housing Administration (FHA), which guarantees reverse mortgages to seniors, insure nearly 90 percent of all residential mortgages. The costs beyond the direct infusion of the $188 billion bailout are much higher: an estimated $7.4 trillion loss in real property equity, for one. The GSE "privatized gains and socialized losses" model remains

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