Could the housing finance market be in for a shake-up? It's been a generous few years for home borrowers with mortgage rates remaining at record low levels as the Federal Reserve increased and sustained its high level of asset purchases. However, in an interview on tax reform May 1, Treasury Secretary Steve Mnuchin hinted that pending reform around Fannie Mae (FNMA) and Freddie Mac (FMCC) is on the horizon, which could send ripples through the lending market. 

What to do with Freddie and Fannie has been a point of contention since the government bailout during the 2008 financial crisis. The government has repeatedly come under pressure over the management and distribution of profits made since the takeover. In February, it took a Washington D.C. circuit court of appeal decision to bar hedge funds from suing the government for seizing profits made by the two lenders. 

The $258 Billion Question

After the financial crisis and the subsequent downfall of both Fannie and Freddie, the U.S. government stepped in to prevent a full-blown capitulation. In doing so, the mortgage giants were put in the hands of the government and became Government-Sponsored Enterprises (GSE), and were granted a $258 billion backstop. The backstop was a credit line to the two embattled lenders to prevent any further damage in the mortgage market. (See also: Fannie Mae, Freddie Mac And The Credit Crisis Of 2008)

Most observers believed the credit line would be maintained indefinitely, but Mnuchin's comments regarding reform of the GSEs have made some believe the credit line in jeopardy. "While our previous view was that this backstop could be maintained indefinitely even after conservatorship ends, we now expect it to be tapered down to zero," Bank of America said in a recent report. "This process could lead to wider spreads and higher mortgage costs, but the exact market reaction will depend on plan specifics which we don't expect until either late this year or early next year, given that Mnuchin said that tax policy will come first."

Trickle-Down Effects

Under this scenario, the debt held by both Freddie and Fannie would lose important benefits. By losing the backstop, it would lose its government status, potentially making it ineligible for money market fund and central bank investors as well as being stripped of its liquidity status under the Basel requirements. Coupled with possible downgrades, the government would have to taper the $258 billion backstop, a potential catalyst for market volatility. 

The Bottom Line

Whatever direction the Treasury goes with Freddie and Fannie, it appears the backstop will be revisited and in time withdrawn. Mnuchin told Fox News the only reason Freddie and Fannie exist is thanks to the large line they have with the government, inferring once the line is withdrawn they would have to seek alternatives. 

"I haven’t said they would be privatized, what I’ve said is ‘I’m committed to housing reform and that we’re committed not to leave them as is for the next four years,'" Mnuchin said.