Will Fannie or Freddie Be Your Next Lender?

Peter G. Miller
OurBroker®

The question of who should make mortgages is moving back into the news, a subject which may mean thousands of dollars in loan savings for individual borrowers.

On one side of the debate we have lenders of every size, while on the other we have government-sponsored enterprises, so-called "GSEs" such as Fannie Mae and Freddie Mac.

The way the system now works lenders "originate" mortgages. That means when you need a loan you turn to a local lender or a lender online, and that company finds the loan program which works best for you, processes the loan, and provides a check at closing.

However, because lenders only have so much money they usually sell some or all of the loans they create. For example, if Main Street Mortgage has $3 million in cash and makes 30 loans of $100,000, the company is out of money (30 x $100,000 = $3,000,000) and out of business unless it can come up with additional cash.

Where can Main Street get new capital? It can sell an asset -- the loans it has originated -- to such buyers as Fannie Mae and Freddie Mac. Where do Fannie and Freddie get the money to buy those local loans? From Wall Street investors who buy mortgage-backed bonds and securities.

So far it looks as though we really have nothing more complex than local retailers and big wholesalers -- the kind of arrangement found in many industries. But there are a few catches.

Local lenders pay taxes at the local, state, and federal levels, and if they sell stock they also have to register shares with the Securities and Exchange Commission. Fannie and Freddie do not pay state and local taxes, and they do not have to register stock with the SEC -- a benefit which may save the companies as much as $500 million a year.

The looming problem is not who makes loans today, but who will make loans tomorrow. So far, Fannie Mae and Freddie Mac make no loans directly to the public, but lenders worry that with the Internet that may change.

Lenders -- like local bookstores and travel agents -- sell a "fungible" product; that is, for many borrowers (but not all) one loan is like another loan. If you need an FHA loan, that loan is the same whether it comes from an online lender, a lender down the street, or a lender across the country. And it follows that if all FHA loans within a given program are the same, then the issue for consumers is price and not whether the loan comes from one lender or another.

Lenders worry that they will largely disappear if we take the efficiencies of the Internet and combine them with the size and advantages of Fannie Mae and Freddie Mac. The result is that lenders have cobbled together a coalition called FM Watch to assure that Fannie and Freddie do not enter the consumer marketplace directly.

The debate is being framed in terms of who should benefit from the efficiencies and advantages enjoyed by Fannie and Freddie --shareholders, borrowers, or tax collectors.

Ralph Nader, for example, argues that Fannie and Freddie shareholders are receiving too much benefit for too little risk.

"The Congressional Budget Office (CBO) conducted an extensive study of Fannie and Freddie," Nader testified before the House Budget Committee in June.

"CBO estimated that the credit enhancement stemming from the government links was at least $6.5 billion in 1995. According to CBO, Fannie and Freddie pass only part of that subsidy on to home buyers -- about $4.4 billion -- with the remainder of the credit enhancement subsidy pocketed by private shareholders, the corporations' executives and lobbyists. In other words, for every $2 delivered to home buyers, Fannie and Freddie take $l of the subsidy for themselves."

But Fannie and Freddie argue that what they do results in lower loan costs, costs that would be threatened if the companies are subject to higher taxes.

For instance, one idea has been to tax the investment portfolios held by each company. But Frank Raines, Fannie Mae's chairman and CEO, points out that merely by increasing mortgage costs by as little as .25 percent in fees and taxes would price out as many as 400,000 prospective home buyers.

So far Fannie and Freddie have successfully defended their territory, and lenders have defended their turf as well. There are no new taxes on GSEs and Fannie and Freddie are not offering loans directly to consumers. But in any debate where hundreds of billions of dollars are at stake, you can safely bet that the discussion is far from over.

No less important, it may be that Fannie, Freddie, and local lenders are all at risk in the new Internet era. The Web makes all lenders "local," and online lenders have shown that mortgages by modem are both practical and competitive. If in the future we find an online lender who both makes mortgages and sells securities on Wall Street, then mortgage costs may be forced down and the home financing landscape will be entirely changed.

Question Of The Week

Q: A friend and I jointly own a home. She wants to sell the property, I want to keep it, and our ownership agreement gives either party the right to sell the property. What can I do to stop the sale?

A: If the ownership agreement says either party can require the sale of the property, then the matter appears to be decided in advance.

You have a situation where one party wants to sell and one party wants to hold. But does it matter who buys?

You already have an interest in the property. When the property is sold, you and your co-owner will each get a portion of the sale benefits. If you have an idea of the property's value then you know what each ownership portion is worth.

So, rather than sell in the open market, ask your partner if she would consider a selling her interest to you at a fair market price. If you and your co-owner disagree as to the cost of the property, then have an appraiser provide a valuation.

If the property is now financed, then a change in ownership may require either a release from the current lender or new financing.

For specifics, please see an attorney who specializes in realty matters.

Weekly Resource

There's no shortage of Internet hoaxes -- including such gems as "Internet Clean-Up Day" and various company "give-aways." A good place to check out what's real and what's not can be found on the anti-hoax site maintained by the Department of Energy.

Mr. Miller welcomes your questions, comments, and news releases. All correspondence shall become the property of Mr. Miller upon receipt. He can be reached by e-mail at OurBroker.

Published: August 10, 1999

Use of this article without permission is a violation of federal copyright laws.

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Related Articles:

• Economists Fret About Subsidies To Federal Charters
  
• Fannie Mae, Freddie Mac Answer Criticism By Pleading Higher Costs
  
• Fannie Mae Gets Slap On The Wrist
  
• Treasury Statements About Fannie, Freddie Focus Attention On The GSEs
  

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Editor's Note: This article reflects the opinions of Peter G. Miller only and not necessarily the views of this or any other publication, organization or Website owner.

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