Fannie and Freddie – Kicked Out of Their Parents' Basement?

Trump’s new Treasury Secretary, Steve Mnuchin, announced on TV last week he wants to privatize Fannie Mae and Freddie Mac. Fannie and Freddie are government-sponsored enterprises and, as such, are like adult children. The government does not guarantee to support them, but as parents they would never let them fail.

During the financial crisis, when both agencies were essentially bankrupt, the government did what any good parent would do. They placed the kids into conservatorship, moved them into the basement and took away their credit cards. The government bailed out both to the tune of $188 billion. Since then, the kids have paid back over $241 billion and are clearly profitable, yet still they live in the basement.

So why have these kids failed to launch some 8 years since the crisis?

It is an understatement to say housing is important to both the U.S. economy and to voters. The ability to get a 30-year fixed rate mortgage with a thin down payment at a small spread above the 10-year Treasury is a massive subsidy. This subsidy is one reason why the home ownership rate is so high in the U.S. Additionally, the amount of mortgage debt in the U.S. is over $10 trillion, and the combined assets of Freddie and Fannie are in excess of $5 trillion—these are really big numbers!

Nobody knows how Fannie and Freddie can be privatized, as the federal government is between a rock and a hard place. Congress can’t disrupt the housing market for fear of slowing the economy or losing voters, but Congress can’t support the kids forever. It’s not healthy -parents can relate.

So how could this impact your fixed income portfolios?

First, if the government subsidy is taken away, mortgage bonds should offer more yield and may again be a good value for your portfolios. On the flip side, higher mortgage rates would hurt the economy. Second, someone will make money if this service is privatized, and we suspect the winners will include the large money center banks. Currently, banking is one of our favorite industries. Finally, kicking the kids out of the basement will be unsettling for the kids, parents and the overall fixed income markets – and this level of uncertainly should be reflected in higher risk premiums, which present both opportunities and perils.

Things are moving fast in the fixed income markets, and yet we are encouraged by higher rates, which translate to more income – the whole reason behind creating fixed income portfolios!

Source: The Financial Times, Bloomberg, The Wall Street Journal, Freddie Mac and Fannie Mae