Senate Bill to Abolish Fannie and Freddie Hits the Floor

A bill to abolish the two government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae will finally be introduced today after months of preparation.  Although not widely believed to be passable in its current form, any iteration is likely to be significant for the housing market.  As it sits, the bill would replace the GSEs with a reinsurer of mortgage-backed securities (MBS) to act as a backstop to private capital in a crisis.

The legislation will be proposed by a bipartisan group of senators led by Bob Corker (R-TN) and Mark Warner (D-VA). It would liquidate the two GSEs, which have been in government conservatorship since 2008, within five years., replacing them with a reinsurer, tentatively named the Federal Mortgage Insurance Corporation. It is designed to insure a liquid mortgage market would exist even in times of crisis while protecting taxpayers from loses. The reinsurance would kick in only after private creditors had absorbed a 10 percent loss of the principal balance of the affected mortgage-backed securities should the loans go bad.

Reuters reports that analysts were calling the legislation a first step that faces an uphill battle in Congress, especially in the House where some members want the government completely out of the housing finance business. The news agency quotes Jaret Seiberg, a senior policy analyst at Guggenheim Securities, who said that there "is almost zero chance the bill introduced today will be adopted" as it is currently written.

The bill would require private entities to buy mortgages from lenders and issue them to investors as securities, according to the discussion draft. Private equity would be required to absorb a 10 percent loss of the principal underlying those new mortgage-backed securities if the loans went bad.

The Federal Mortgage Insurance Corp. would charge and collect fees to cover its operating costs and maintain a catastrophic fund - probably similar to FDIC depositor insurance. It would also continue efforts recently initiated by the Federal Housing Finance Agency (FHFA), the GSE conservator, to build a common securitization platform for pooling mortgages, issuing and selling MBS.

Since they were placed in conservatorship the GSEs have been shored up with an aggregate $187.5 billion in money from the U.S. Treasury but each is now posting record profits. A discussion draft of the proposed legislation proposes that any proceeds from the wind down of the GSEs would be paid first to Treasury which holds $188 billion in senior preferred stock in the two. Any remaining moneys would be paid to preferred stockholders then to common shareholders of each. Several large stockholders recently filed suit against the government for losses they claim were caused by the government's seizure of the companies.