Trump’s Treasury Pick Looking to Privatize Fannie and Freddie

Donald Trump’s US Treasury nominee Steven Mnuchin sent mortgage markets into a frenzy when he said privatization of Fannie Mae and Freddie Mac should begin and that the incoming administration would “get it done reasonably fast.” Comments about the two mortgage finance titans shot their stocks up over 30% according to Bloomberg.

Both financial institutions have worked as clearing houses for mortgages, buying them from private lenders, packing them into securities, and stamping them with a US government’s guarantee. Privatization means increasing risk to some, but Mnuchin was quick to dispel any worries. “We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again. But we’ve got to get them out of government control,” he stated.

Unfortunately for the free market, Mnuchin’s plan for the two government-backed mortgage companies didn’t include completely closing their doors, which is the only real solution to avoiding another housing market collapse. Both Fannie Mae and Freddie Mac were private companies before their take over in 2008. The only difference between the two lenders and other mortgage companies was they were backed by the Federal government, who essentially co-signed for riskier borrowers.

Mortgage-backed securities were one way this governmental backing created investment environments that were too safe and lacked the incentive to guard against risk. Privatizing Fannie Mae and Freddie Mac would create the same moral hazard while making them truly “private” would destroy the housing market.

Simply removing government backing and making Fannie Mae and Freddie Mac truly private would tighten lending requirements to the point that would tank the housing market. Higher income and credit score requirements would disqualify so many potential borrowers, the price of homes would take a significant dive.

The focus on home lending comes at a time when homeownership rates are at historic lows and when private lenders are seeing a significant drop in mortgage applications. The major short turn cause for the downturn is higher interest rates and the expectation the Fed will raise the benchmark rate in December. Higher borrowing costs are beginning to slow refinancing applications, which fell 9.4% last week, according to USA TODAY. While higher interest rates are increasing home prices, the number of new mortgage applications has remained relatively strong.

Overall, next year’s rate of mortgage originations is likely to fall because of the drop-off in refinancing, according to Mike Fratanatoni, MBA chief economist. Fratanatoni told USA TODAY he believed new purchase mortgages would increase about 10% in 2017 “based on the strengthening economy, employment, and housing demand.”

More stringent requirements for lenders within a privatized Fannie and Freddie might also impact housing sales, but would inevitably lead to a safer market overall.

While higher interest rates are pushing house prices and refi’s down, used car prices are falling as trade-ins increase. In a recent report by Edmunds.com, record numbers of car shoppers are trading in old cars for new ones despite being upside down, according to the WSJ. The number of new 2016 car purchases with negative equity reached a record average of $4,832, and as a result, some anticipate a spike in defaults.

Along with their old cars, car buyers are trading in their old debt for new loans. More trades are increasing supply and driving down auto prices. A combination of lower costs and high default rates will mean lenders stand to lose more on repossessions across the board.

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