Making Mortgage Finance Private Again

Lawrence Gillum (00:00):

In a recent post on X, formerly Twitter, President Trump stated that he's working on taking these amazing companies public, and the U.S. government will keep its implicit guarantees. Those amazing companies he's talking about are Fannie Mae and Freddie Mac, the dominant government sponsored enterprises in the US mortgage market and taking them public, also known as privatizing in this case. And yes, it's confusing and would transform housing finance, even with explicit government backing, ensuring their stability. So in this addition of LPL Street View, we unpack what that could mean for the mortgage market and ultimately the mortgage-backed securities market.

Lawrence Gillum (00:36):

Fannie Mae and Freddie Mac established a support for housing by purchasing mortgages from lenders and securitizing them into mortgage-backed securities, MBS for short, have been under government conservatorship since the 2008 financial crisis. Recently, president Trump posted on X about plans to privatize these GSEs, turning them into publicly traded companies while maintaining implicit guarantees. Though details are scarce and a formal plan may not emerge until later this year or into next year, markets are already reacting as investors await clarity on whether that government guarantee will remain after they go public. Privatizations affect on mortgage rates hinges on whether the government retains either an explicit or implicit guarantee, like a backstop for catastrophic losses. With a government guarantee, investor confidence would keep borrowing costs low, potentially raising mortgage rates by just 20 to 50 basis points due to the shift to a privatized model. Without it, a higher perceived risk could push rates up by 50 to a hundred basis points, making home ownership less affordable, slowing home price growth, and impacting local economies.

Lawrence Gillum (01:44):

Currently, mortgage spreads the premium over the 10-year year yield are at 2.5% down from a high of 3.4%, but above the historical average of 1.75%. Uncertainty about the guarantee is already influencing these spreads. So what does this have to do with fixed income? Within fixed income markets? Mortgage loans that are bundled and sold to investors are a big component of the core bond universe. Agency MBS is the second largest sector behind treasury securities, so the decision to privatize the GSEs will have a market impact on the MBS market as well. The $11 trillion mortgage-backed securities market dominated by Fannie and Freddy's Agency MBS hinges on government backing with a government guarantee. MBS retain near risk-free status keeping yields and spreads low and sustaining demand from pension funds and insurance companies. Without a guarantee, agency MBS lose their safe haven appeal, likely requiring higher yields to attract investors, reducing liquidity as funds shift to corporate bonds or other assets. And after the recent rate hiking campaign by the Federal Reserve, MBS yields remain elevated relative to not only history, but also relative to other high quality fixed income markets. In fact, currently MBS yields are in line with lower

Lawrence Gillum (02:58):

Quality investment grade corporate bonds. Investment grade corporate bonds not only carry higher credit risk, the corporate market is 50% triple B rated, but also have higher interest rate risk. Historically, investment grade corporate yields have been around 50 basis points higher than MBS yields due to these additional risks. While we don't have a strong view on whether the government should privatize the GSEs or not, we believe it is essential for the government to retain that government guarantee if indeed they go the privatization route, which we think could take years. By the way, the housing market and subsequent securitization of mortgage loans are an essential part of our economy and fixed income market respectively. The removal of that guarantee would disrupt both markets and make housing less affordable. Moreover, as the second largest sector within the core bond universe, MBS offer attractive high quality options for investors that don't want or need to take on a lot of credit risk to generate income.

Lawrence Gillum (03:54):

So more risk averse investors may be inclined or even required to significantly scale back their holdings of agency MBS, which could lead to selling or fewer purchases if the government guarantee is removed. Either way, given the supply and demand dynamics and the impact on mortgage rates, even incrementally less demand would result in upper pressure on mortgage rates. That said, we continue to think the risk reward for agency MBS is attractive, particularly relative to lower rated corporate credit yields and spreads remain elevated relative to historical averages, and with the Fed lowering interest rates over the next few years, falling interest rate volatility could be a tailwind to the asset class. No guarantees here. Of course, that's it for now, but for more information on global capital markets, make sure you're following us on our social media accounts. Take care, everyone.