Housing Finance Reform and Agency Supply Shortage

Abstract

The Johnson-Crapo bill represents another concrete step towards the resolution of the future of Fannie Mae and Freddie Mac and one that will further reduce the supply of government agency debt. This presents a serious challenge to the management of cash portfolios due to the core holdings status of agency debt. Money market fund reform may force more prime fund shareholders into the government space. Investors should prepare for the challenge by considering credit investments and longer maturities, and by locking in yield differentials today. Separately managed accounts may help cash professionals to explore options that are not available from money market funds or banks deposits.

Introduction

Within the world of financial regulatory initiatives, housing finance reform has been a key area of interest for fixed income investors. For decades, short-term cash investors have relied heavily on an ample supply of highly liquid discount notes and coupon bonds from the housing government sponsored enterprises (GSEs). However, the introduction of the Johnson-Crapo Senate bill in March 2014 may bring GSE reform one step closer to its final outcome and it may further curtail debt issuance from two of the GSEs, namely Fannie Mae (FNMA) and Freddie Mac (FHLMC). Although the process of winding down Fannie and Freddie may take years to complete, the shrinking of supply of GSE issuance in the short-term funding market may be the first major development to impact investors.
The Johnson-Crapo Legislation
On March 16, 2014, Senate Banking Committee Chairman Tim Johnson (D-South Dakota) and Ranking Member Mike Crapo (R-Idaho) unveiled a bill to reform housing finance after a broad agreement was reached amongst Committee members. The Johnson-Crapo bill, fashioned after the Corker-Warner bill in 2013, is another concrete step towards resolving the long-term future of Fannie and Freddie which currently remain under the government’s conservatorship.
The bill, as proposed, will eliminate the two housing GSEs and a new Federal Mortgage Insurance Corporation (FMIC) will replace the firms’ current regulator Federal Housing Finance Agency (FHFA). The FMIC will provide reinsurance on new conforming mortgage loans and its mortgage insurance fund will provide explicit government guarantees to mortgage investors once an initial 10% loss is borne by private parties. Any shortfall in the insurance fund will be replenished by a $100 billion credit line from the U.S. Treasury, and ultimately recuperated through higher future guarantee fees. As the government winds down Fannie and Freddie over a five-year period, their outstanding GSE debt and mortgage backed securities will become explicit obligations of the U.S. Treasury.
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