Fannie Mae and Freddie Mac have built a trillion-dollar business insuring mortgages. But increasingly they are doing something entirely different: selling off mortgage-backed securities without any guarantee that the two firms will pay in the event of a default.
Sales of these so-called credit-risk transfers are expected to reach a record $15 billion this year, up from $13 billion last year, according to JP Morgan Securities. The trend comes as lawmakers debate the future of the two mortgage giants and ponder a potential smaller role for the federal government in the U.S. housing market.
“The government’s footprint in the mortgage market is receding quickly and significantly,” Moody’s Analytics’ chief economist Mark Zandi told the Wall Street Journal.
Fannie and Freddie buy mortgages from lenders, stamp them with a repayment guarantee in the event of a default and then sell them off in the form of mortgage-backed securities. In return for the guarantee, bond investors accept lower returns.
Credit-risk transfers, in contrast, carry no such guarantee and come with higher returns. But as investors grow more bullish on the housing market, the average yield on one version of the transfers has halved over the past two years, according to the Journal.
The government has always implicitly backed Fannie and Freddie’s repayment guarantee and now holds the two firms in conservatorship. Selling mortgage bonds without the guarantee reduces the role of the federal government in the mortgage market, and some advocates of credit-risk transfers would like to see Fannie and Freddie dismantled altogether or replaced with private firms.