Flash Insights: Mortgage market makeover—potential privatization of Fannie and Freddie

Key Takeaways:

• The potential exit of Fannie Mae and Freddie Mac from government conservatorship is a complex endeavor, involving complicated technical details and what an alternative business model should look like.
• Although government conservatorship has helped promote stability for the US mortgage market, conservatorship is not meant to be permanent. There are growing calls to reduce government’s footprint and taxpayer’s exposure to the next housing downturn.
• Amid the hurdles, we expect continued headline noise regarding the subject, potentially leading to bouts of mortgage-backed securities (MBS) volatility. Franklin Templeton Fixed Income is here to help assess the challenges ahead.  
   

Main functions of Fannie and Freddie

Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are government-sponsored enterprises (GSEs). Their main role is to provide US housing market stability by ensuring mortgage market liquidity and affordability, mainly through the purchase of home loans from banks and other mortgage lenders and bundling them into interest-bearing agency mortgage-backed securities (MBS), in a process known as securitization, to be sold to investors in the secondary market. The implicit government backing enables Fannie and Freddie to pass that credit worthiness on to the end investor via its guarantee of mortgage loans, which has helped keep home loan interest rates relatively stable and low for homebuyers.  

The 2008 global financial crisis (GFC) and conservatorship

In the aftermath of the 2008 global financial crisis, Fannie Mae and Freddie Mac were placed into conservatorship by the Federal Housing Finance Agency (FHFA). The goal was to further stabilize and ensure the continued functioning of the US mortgage market. The US Treasury injected capital into Fannie Mae and Freddie Mac via preferred stock purchase agreements (PSPAs) to prevent their collapse. This helped restore investor confidence and ensured that mortgage credit remained available during the financial crisis.

In return, the US Treasury received senior preferred shares and warrants for up to 79.9% ownership in each company (Fannie and Freddie).

¹While in conservatorship, Fannie and Freddie continued to purchase and securitize mortgages to prevent a total freeze of the mortgage lending system. Despite the stabilizing effects on mortgage rates, conservatorship for Fannie and Freddie was not meant to be permanent.  

Why privatize?

Although a Housing Reform Plan that outlined various administrative and legislative actions toward privatizing GSEs was published in 2019 during US President Trump’s first term in office, privatization efforts were not initiated as the COVID-19 pandemic took hold. A renewed push for privatization is likely under President Trump’s second administration.

The most vocal supporters of conservatorship exit include small government advocates who would like to reduce government footprints in favor of more private-sector involvement in the mortgage lending channel. The aim is to shift financial risk away from taxpayers back to private investors in the hopes of inducing investor discipline and discourage reckless lending as implicit government backing no longer exists. The reasoning goes that more market competition would encourage better pricing and innovation.

Some proponents of conservatorship exit believe that government involvement in the mortgage market leads to price distortion and artificially low mortgage rates. Lowering mortgage rates, however, through the development of a deep secondary market, was the reason behind creating the MBS market. Lastly, hedge funds tend to be vocal supporters of conservatorship exit, as they have strong economic incentive for privatization, which we will explore next.

Potential costs and hurdles of privatization

Without implicit guarantees of government backing, higher mortgage rates could result, as banks would likely be required to hold far larger capital reserves. This could potentially lead to agency MBS becoming a less attractive investment alternative, in our view. US banks own approximately 30% of the agency MBS market and invest in the sector for its low risk-based capital requirements. Furthermore, investors would likely demand higher rates for lower-income borrowers and those with weaker credit profiles, which could translate into higher mortgage costs as well. Lenders may enact stricter borrowing requirements, making it harder for some buyers to qualify for a loan. During times of market difficulties such as the 2008 GFC and the COVID-19 pandemic, Fannie and Freddie played a crucial role in stabilizing the housing market. A fully privatized system might not have the same ability to step in during economic downturns.

Determining the level of government support after the exit from conservatorship has also emerged as one of the key issues surrounding privatization. Those in favor of retaining some level of government support have pointed out government involvement is integral to the securitization of mortgage loans by the GSEs. At the same time, there is a need to reduce taxpayer exposure by either increasing GSE capital requirements or reducing the GSE footprint; it is necessary to resolve these opposing forces.

As part of the exit plan, would the US Treasury forgive its ownership interest in the GSEs? The original 2008 PSPA agreement gave the Treasury a very large ownership interest in the GSEs consisting of two parts: a) a warrant on 79.9% of the shares of each GSE, and b) senior preferred shares in the two GSEs with a current face value of US$334 billion.² The Treasury has so far received far more cash dividends than it had invested into the two companies, which has resulted in calls for Treasury to write off its senior preferred position as in theory, Treasury has already been paid back. The write-off of Treasury’s preferred positions would primarily benefit historic publicly traded common and junior preferred shares, which are widely believed to be held chiefly by institutional investors such as hedge funds or private equity firms. However, it is not entirely certain that the Treasury has the authority to write off its monetary interest, which may require legislative action from Congress.

How would agency MBS be treated by rating agencies and would government guarantees be explicit, implicit or non-existent? Uncertainty around the implicit guarantee could cause ratings downgrades of GSE-backed bonds and impact their capital treatment on bank balance sheets. Either scenario could potentially disrupt the mortgage market. The original Housing Reform Plan published in 2019 recommended an explicit government guarantee, although the plan did not offer specifics on how such a guarantee would work.

Moreover, the lack of government backing for Fannie and Freddie could initiate a significant shift to Ginnie Mae-guaranteed (Government National Mortgage Association) mortgages, which are explicitly guaranteed by the government. This would shift the risk of a housing downturn back to the US taxpayer, the risk which privatization advocates hope to dial back.  

In January 2025, the Treasury and FHFA issued a joint statement outlining changes to the conservatorship agreement that restores the Treasury’s right to consent in ending conservatorship of GSEs. Privatization efforts will most likely require administrative and legislative components. While administrative issues could be addressed by GSE regulators, getting a divided Congress (with a slim Republican majority) to agree on legislation related to GSE privatization could prove to be a complicated endeavor given the sensitivities around housing affordability.  

Lastly, what would the post-exit GSE model look like? We will examine this question next.

Possible alternatives?

Appropriate reforms will most likely require striking a balance between government support and private market discipline that both encourages competition and limits government liability. At this stage, calls from the Trump administration to exit conservatorship are not accompanied by a clearly stated alternative business model recommendation.

Potential alternatives include converting Freddie and Fannie, after further capitalization, into regulated utility entities, where they retain government sponsor status but with restrictions on risk-taking and profit distribution. With this proposal comes the question of whether FHFA would set GSE guarantee fees going forward, and what would be the basis to determine this fee?

Another alternative involves expanding the utilization of instruments such as agency credit risk transfers that shift some risk to private markets. A third potential alternative involves keeping GSE status but with strengthened oversight such as a higher capital reserve requirement.

Lastly, Treasury Secretary Scott Bessent has suggested the possibility of placing the government’s ownership stakes in Fannie and Freddie into a sovereign wealth fund, which President Trump has sought to create via an executive order. This proposal would help recapitalize the firms and speed up privatization without putting taxpayers’ stakes on the line. Some would argue, however, that this proposal does not address the PSPAs and that taxpayers are still owed US$334 billion (as mentioned previously).

Final thoughts  

GSE reform, including conservatorship exit and selection of a post-exit business model, is a complex and time-consuming endeavor which will likely take years to implement. Resolution will require agreements on highly technical issues (as noted previously) that are not visible to the average mortgage borrower. While conservatorship is not a permanent solution, the mortgage market has worked well with conservatorship in place, which somewhat takes away the urgency to reform GSEs.   

Amid the hurdles, we expect continued noise surrounding major headlines and upcoming appointments by the Trump administration may lead to sporadic bouts of MBS volatility. We believe, however, that with potential challenges come opportunities.