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Week of March 31, 2014: The Future of the Government Sponsored Enterprises (GSEs)

The newly indoctrinated Federal Reserve (Fed) Chairwoman, Janet Yellen, hosted her first Federal Open Market Committee (FOMC) meeting, and as widely anticipated, reduced the monthly pace of asset purchases by $10 billion to $55 billion per month.  The overall outlook on the economy was mixed as the FOMC released statement reflected a slowdown in growth and housing related activities which have been impacted by weather.

As discussion surrounding the future of the GSEs continues to make headlines, it would be prudent to take look at current and proposed legislation and the potential impact to the mortgage market. Since the subprime crisis of 2007-2009, Washington has deemed it necessary to intercede and change government involvement in the home mortgage process. With a goal of protecting taxpayers GSE losses, members of Congress in Washington aim to create policies that would promote growth. These policies include but are not limited to a more efficient mortgage process and lower mortgage rates. A  limitation or elimination of the GSEs could reduce the efficiency of the mortgage process and on the margin cause mortgage rates to go higher.  Washington seems to realize this could be a result and also the reality that any solution would be phased in over a period of years.

The two most discussed bills on the GSE issue currently are the Johnson (D-SD) - Crapo (R-ID) bill and the Corker (R-TN) - Warner (D-VA) bill.  Even though both bills are bipartisan, it appears that opinions about the future of the GSEs differ by party lines.  Republicans generally favor little to no government involvement in the housing picture while Democrats favor some or more government involvement. Each of these bills favor the creation of an entity, the Federal Mortgage Insurance Corporation (FMIC), to replace Fannie Mae (FNMA) and the Freddie Mac (FHLMC). The legislation also calls for existing FNMA and FHLMC securities to be converted into FMIC with the introduction of a privately held first loss piece. The proposed 10% first loss piece would essentially create a $400 billion market out of roughly $4 trillion of GSE mortgages. Of course, all of this will take time as both bills want to maintain an efficient market with measures in place to ensure as much liquidity as possible, for example a liquid TBA market.

We would be surprised if any decisions are made in 2014 with the mid-term elections coming and the fact that any agreement would include a phase-in stage that could take as long as 5 years. On the margin, we do not view this as negative for GSE securities and under certain scenarios it could be good for these securities.  These scenarios include a possible shrinkage of this market as well as securities that would not pay as quickly as before due to costs (fees) and higher mortgage rates due to reasons mentioned above.

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