A few months ago I stumbled on a briefing by the Cato Institute that proposed a mammoth move by the Federal government that at the time I thought could never happen. No, it has nothing to do with Greenland becoming the 51st state. (Although I can agree with some of the arguments made to purchase it!)

It has to do with what Bloomberg calls a “stodgy 87-year-old company” – Fannie Mae and its corporate relative Freddie Mac. These two companies guarantee roughly 70% of US home mortgages.

The report proposed that these two government-sponsored enterprises (GSEs) be privatized by sending the corporations into receivership. The sale out of receivership would require Congressional approval, but it would effectively remove $8 trillion of liabilities from the government’s balance sheet. This plan was originally proposed by the Trump administration during his first term. Now that plan has resurfaced after some of his top allies have renewed the call to privatize the two mortgage backers.

Billionaire investor and Trump supporter Bill Ackman, who owns shares of Fannie and Freddie, has led the charge, advocating on social media for the incoming administration to exit from their government conservatorship.

How We Got Here

Fannie Mae – the Federal National Mortgage Association – was established in 1938 to make affordable mortgages available to middle- and low-income Americans. Freddie Mac – the Federal Home Loan Mortgage Corporation – was founded in 1970 to do the same.

The private but tightly regulated Fannie Mae bought mortgages from banks and started packaging them into mortgage-backed securities in 1981, which it sold back to banks or other financial institutions. In exchange for a fee, it guaranteed the assets were fail-proof, allowing investors to recoup their money even if homebuyers defaulted on their loans.

Now fast forward to 2007 when it was found that many of these mortgage-backed securities held very risky loans. Then the housing bubble burst, mortgages defaulted and housing prices declined.  This caused mortgage-backed securities to essentially become worthless. The institutions that held them looked back to Fannie and Freddie to cover their losses.

Suddenly, Freddie and Fannie found themselves on the verge of bankruptcy, upending the banking industry in a way not seen since the banking crisis of 1929. To avoid this, the federal government and private investors injected them with billions in loans. In exchange, Uncle Sam put them in federal conservatorship.

Now, all their profits, which are derived from the loan-guaranteeing fees they charge banks, are remitted to the Treasury. Private shareholders own the other 20% of Fannie and Freddie, holding their diminished stocks mostly in hopes of eventual privatization.

Why Does Ackman Care?

For Bill Ackman and other private shareholders of Fannie and Freddie, privatization could mean an enormous windfall. After Trump’s election, shares of the two entities more than doubled, and then took another leg sharply higher after Ackman expressed his conviction that Trump would put an end to conservatorship.

Both companies became profitable after the housing market stabilized in the early 2010s and have since built up about $147 billion in equity. While that equity technically belongs to the government, some argue that Uncle Sam has already recouped all the cash it loaned Fannie Mae and Freddie Mac while making a $25 billion profit.

Under their federal status, Fannie and Freddie also enjoy? local and state tax exemptions, and lower federal borrowing costs.

The problem, though, is the two combined entities have been losing billions of dollars each year as seen below.

Investors hoped the transition would happen during the first Trump administration, only to see that effort fizzle. Now Bill Ackman and others believe a second Trump administration can get it done, even if it still takes some more time.

Some Advantages to Privatize

In his post on X, Ackman said, "A successful emergence of Fannie and Freddie from conservatorship should generate more than $300 billion of additional profits to the Federal government.”

Ackman estimates that the Treasury has already received $301 billion of cash distributions from the two corporations. Privatizing will also remove roughly $8 trillion of liabilities from our government’s balance sheet.

Could Trump actually make this happen in his second term? Ackman said, "Trump is a big deal guy, and this would be the biggest deal the world has ever seen. I am confident he will get it done.”

But Also Disadvantages

He also expresses concerns that ending government conservatorship could lead to the small, but non-zero, risk of a repeat of conditions that led to the 2008 financial crisis.

Under conservatorship, Fannie and Freddie have operated under strict federal oversight, dictating the structure and underwriting standards for the mortgages that they are allowed to purchase and securitize. That would likely disappear under privatization.

But it could be bad news for future homebuyers. Ending the conservatorship would put upward pressure on mortgage rates. The commonly used 30-year mortgage could disappear, deemed too risky by a privatized Freddie and Fannie.

Chief Economist Danielle Hale with Realtor.com writes, “Mortgage rates would likely move higher, because right now, under conservatorship, there is a government guarantee that if Fannie and Freddie were to get into any trouble, they would be bailed out by the government, and thus investors would be bailed out,” she says. “Which means consumers currently get lower mortgage rates, because investors are willing to lend without demanding as much of a risk premium.”

The Bottom Line

Privatization could allow them to get more creative, and support mortgage structures that would make it easier for more people to buy a home. The downside of that scenario is that if standards become too loose, risky home loans could once again proliferate, teeing up a potential repeat of 2008.

Would privatization get to the end result of Trump’s promise of a 3% mortgage rate? I sincerely doubt it. But the end of government conservatorship could lead to the small, but non-zero risk of a repeat of conditions that led to the 2008 financial crisis.

[Henry]

• Like us on Facebook
• Share on Facebook
• Share on Twitter