A dangerous playbook is being revived for the giant US housing agencies
Increased buying of mortgage securities by Freddie Mac and Fannie Mae marks a return to a risky business model
Sheila Bair
President Donald Trump has nominated Kevin Warsh to be the next chair of the Federal Reserve.
But his administration is already busy attempting to influence interest policy.
Bill Pulte, head of the Federal Housing Finance Agency, has directed housing giants Fannie Mae and Freddie Mac to buy up vast amounts of mortgage securities in a well-intentioned but misguided effort to lower mortgage rates.
This marks a return to the risky business model that contributed to the 2008 financial crisis and led to the companies’ failures.
It could reignite housing inflation while making it more likely that the companies will run into trouble again, putting taxpayers and the financial system at risk.
The companies, known as government-sponsored enterprises (GSEs), lie at the heart of mortgage finance in the US.
Historically, they had a straightforward business model: purchase well-underwritten mortgages from lenders, package them into mortgage-backed securities and sell these to investors.
The GSEs protected investors against credit losses on the mortgages they securitised, but not against interest rate and market risks.
In the 1990s, the GSEs decided they could make bigger profits if they kept large holdings of mortgages and MBS in their own “retained portfolios”.
Essentially, they became giant hedge funds.
Bond investors treated their debt as implicitly backed by the federal government.
This enabled the GSEs to issue bonds at exceedingly low rates and invest the proceeds in higher-yielding mortgages and MBS.
This interest rate arbitrage became the major driver of their profits as they amassed combined portfolios which peaked at $1.5tn, more than a third of the MBS market at the time.
Their earnings soared, as did their share prices and executive compensation packages.
Alas, their bungled efforts to manage and mask the volatility and risks of such a massive portfolio led to major accounting scandals.
But instead of reining them in, their regulator allowed them to buy Wall Street’s risky subprime mortgage securitisations in addition to their own.
This was done in the name of expanding home ownership — the same rationale the Trump administration is using — but helped fuel a housing bubble.
Predictably, when the financial crisis hit, their portfolios suffered huge losses.
The FHFA placed them into conservatorship, where they are still, and the Treasury department infused $200bn to keep them operating.
Now, the GSEs have returned to their old playbook.
They increased their retained portfolios by more than $90bn in 2025 and, as instructed by FHFA, are buying $200bn more.
This takes them up to their post-crisis cap of $450bn, triple the size at the start of 2025.
This is a major shift from the post-crisis consensus to shrink and limit the GSEs’ retained portfolios.
After 17 years in conservatorship, the GSEs are even less well-equipped to manage the volatility and financial risks of such a large portfolio than they were in 2008.
With capital levels still below regulatory minimums, they have limited capacity to absorb losses.
At the same time, a $450bn portfolio is only about 4 per cent of total outstanding MBS.
It will have a minor impact on mortgage rates.
The administration has promised not to lift the caps, but will that hold as Republicans face tough off-year elections this fall?
There are no quick fixes to housing affordability in America.
We need to increase the supply of affordable homes and that takes time.
Huge government buying of MBS will only lead to housing inflation as we saw before the 2008 crisis and again, during the pandemic with the Federal Reserve’s own trillion-dollar purchases of MBS.
There are signs that supply and demand are finally moving towards equilibrium. Real home values actually edged down last year.
This is not the time to exacerbate imbalances by stimulating demand with large mortgage rate reductions.
The administration hopes a potential GSE stock offering could help the US with its fiscal challenges.
But if the companies need another bailout, they will be a drain on the public purse.
Potential investors will not want to buy stock in thinly capitalised companies with risky balance sheets and without the government backing that Trump has promised.
That is the inherently unstable, pre-crisis model of privatising profits and socialising losses.
The Trump administration is reaching back to the past to guide the GSEs’ future.
It will not end well.
The writer is a former chair of the US Federal Deposit Insurance Corporation, a former chair of Fannie Mae and author of the upcoming book ‘How Not to Lose a Million Dollars’
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