The 30-yr fixed rate mortgage is a unique feature of the US mortgage market that significantly improves affordability and is vital to maintaining current home values. Fannie and Freddie have historically been, and continue to be, essential to allowing for widespread access to the 30-year fixed rate mortgage at a reasonable cost.
Since Fannie (FNMA, Financial) and Freddie (FMCC, Financial) were put into conservatorship in 2008, there have been a variety of proposals to replace or wind them down, however, none of the proposals have been adopted because there is simply no credible alternative to Fannie and Freddie. Fortunately, there is a relatively quick and simple solution to the current situation: Fannie and Freddie’s business models can be reformed by significantly increasing the GSE’s capital requirements, eliminating their fixed- income arbitrage business, substantially strengthening their regulatory oversight, and developing appropriate compensation and governance policies.
We believe the new administration has the willingness and ability to make the necessary changes to Fannie and Freddie’s business model to preserve widespread access to the 30-year fixed-rate mortgage. The new Treasury Secretary, Steven Mnuchin, is a mortgage market expert, and his recent public comments highlight his desire to reform Fannie and Freddie:
“[We have got to] get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe. So let me just be clear we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again but [we have got to] get them out of government control.” (Footnote: Nov. 30, 2016)
“[…] it’s right up there in the top 10 list of things that we’re going to get done and we’ll get it done reasonably fast.” (Footnote: Nov. 30, 2016)
“For very long periods of time, I think that Fannie and Freddie have been well run without creating risk to the government, as well as they’ve played an important role…I believe these are very important entities to provide the necessary liquidity for housing finance and what I’ve committed to is that I will work with both of the Democrats and Republicans. What I’ve said and I believe, we need housing finance reform, so we shouldn’t just leave Fannie and Freddie as is for the next 4 or 8 years under government control, without a fix. I believe we can find a bipartisan fix for these so on the one hand we don’t end up with a giant bailout, on the other hand that we don’t run the risk of completely limiting housing finance.” (Footnote: Jan. 19, 2017)
In 2016, Fannie and Freddie’s total shareholder returns were 137.8% and 130.9%, respectively, as the share prices rose dramatically after the election. In the first two months of 2017, Fannie and Freddie’s share prices have declined nearly 25% after a ruling in the appellate court upheld most of the original rulings of the D.C. District Court in September 2014. We think the market has overreacted to the recent ruling, and several other legal cases, including the Court of Federal Claims case under Judge Sweeney, continue to proceed favourably.
We believe that Fannie and Freddie offer a compelling risk-reward as there are various scenarios which will generate a many-fold multiple from current levels. While a total loss is possible, we believe the probability of a total loss is relatively modest, and has become lower in the new political environment.
From Bill Ackman (Trades, Portfolio)'s Pershing Square 2016 annual report.
