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The GSEs dominate in multifamily, but for how long?

The government-sponsored enterprises (GSEs) Freddie Mac and Fannie Mae have undergone their own kind of arms race in recent years, vying for supremacy as the top financiers of U.S. apartment loans. Under Mel Watt's leadership as director of the Federal Housing Finance Agency, or FHFA, (which acts as the GSEs' conservator), Fannie and Freddie have hugely increased the volume of loans that they bankroll in the multifamily space.

Freddie has come out on top as the No. 1 financier of U.S. apartment loans, with Fannie close behind, but the days of the GSEs dominance could be numbered.

multifamilyThe Trump administration is expected to scrutinize the GSE multifamily business closely once Watt’s term ends in January. Watt is also now the focus of a sexual-harassment probe filed against him by a former female employee that has the potential to force him out sooner.

Unlike their single-family business, the GSEs’ lending in multifamily is subject to a federal cap, but the enterprises tend to be free to bankroll loans outside this cap if they support affordable housing or other areas of the rental market that may serve a public good but where the available funds are sketchy. The new FHFA director could significantly reduce the GSEs' footprint in the multifamily market by lowering the lending cap or restricting what they can do in the uncapped space that includes affordable housing. 

Critics say the GSEs presence in multifamily has grown far too big during Watt’s tenure and want to see his successor reel them back in — even among those who count themselves as supporters of a strong GSE presence in the greater mortgage market.  

“I would tighten their exclusions [to the cap], and I wouldn’t brag about increasing market share and being the No. 1 [multifamily lender],” said former Obama administration housing advisor Michael Stegman, now a senior fellow at the Milken Institute for Financial Markets, during a panel in July hosted by the American Enterprise Institute (AEI). Conservative think tanks like AEI and the Heritage Foundation find much fault with the growth of the multifamily program.

The first issue involves transparency. Like with their single-family housing program, the GSEs buy up multifamily loans and then package them into securities with a government guarantee. These multimillion-dollar loans are ultimately backed by American taxpayers.The GSEs also rarely disclose the details of these complicated deals in a way that is accessible or transparent to the public.

There also has normally been a bright line between the GSEs and their investors in the secondary market, and the banks and other companies that actually make the loans to apartment-building owners. The critics say these two worlds have gotten blurred at times in multifamily deals, with reports of the GSEs working closely with lenders and borrowers in the primary market. The Mortgage Bankers Association, for example, has complained about this. 

The other complaint is the sheer size and growth of the GSE programs. In the first year of Watt’s tenure in 2014, the GSEs bankrolled $56.6 billion in multifamily mortgages. That jumped to $89 billion in 2015, but the numbers didn’t really explode until 2016, when Fannie and Freddie began vying with each other to fund so-called "green" apartments that feature energy-efficiency improvements.

In 2016, the GSEs bankrolled $112 billion in the multifamily space. The number jumped up to $140 billion last year, representing roughly 53 percent of the total multifamily mortgage market for that year, estimated at $264 billion by the Mortgage Bankers Association.

Some of this growth is due to the recovery in the multifamily market; however, the GSEs' market share has also increased during Watt’s tenure. According to a 2015 Urban Institute study, the GSE share of the market was just 30 percent in 2014.

GSE critics contend that the private sector could largely absorb this business. One person who says this is Thomas W. White, a former Fannie Mae executive and AEI adjunct scholar. He has co-written several articles warning about a recent boom in the debt financing in multifamily largely fueled by Fannie, Freddie and the Federal Housing Administration (FHA), pushing the total debt associated with the sector to $1.31 trillion last year. He is among those who say that the GSEs need to get out of the way of the banks and insurance companies that have traditionally invested in apartment buildings.  

“In our opinion at least, the American capital system is very adaptable, and if there is an opportunity to finance something and make a profit at reasonable risk, they [private-sector investors] will do so,” White told Scotsman Guide News.

“I think it could be replaced. Would it be tomorrow? No. It takes a little while to develop the financial structuring to replace any kind of capital in the system, but I think it would be replaced.”

White also argued that if creating and maintaining affordable housing was the federal government’s goal, it would be better served through direct government intervention, rather than hidden in the books of quasi-private enterprises.

“One of the problems I have always had is that there is no such thing as an actual free lunch,” White said. “All of this attempt to leverage, or some may say bludgeon, financial institutions into taking undue risk is just an attempt to get away from having it declared on the books of the government. I would much prefer that they declare it, so people know what the risk in the whole system is, [and] not hide it.”

Other housing experts doubt that the banks would absorb the GSEs' share easily, though.

The case for the GSEs

Fannie and Freddie, along with the Federal Housing Administration (FHA), still bankroll most loans backed by affordable apartments.The GSEs can structure programs that carry lower-than-market rates and higher leverage levels. Under the current system, the owners, some of them nonprofits, have to keep a fixed number of the apartments, usually at least 80 percent of the building, affordable. GSE multifamily loans have performed exceptionally well too, with delinquency rates for GSE multifamily loans near zero. Much of the risk is also shared with either private investors or by the original lenders.

The GSEs, along with FHA, also ensure a liquid market when the economy turns sour and the banks retreat. In the aftermath of the financial crash 10 years ago, the GSEs financed about 70 percent of the multifamily loans, according to the 2015 Urban Institute study.

“I would doubt that, without Fannie/Freddie and FHA, the market could support the demand for affordable housing and workforce housing capital,” said Michael Berman, a former chairman of the Mortgage Bankers Association and senior adviser to U.S. Housing and Urban Development Secretary Shaun Donovan. Berman said the first outcome of reducing the GSEs' share would likely be higher prices for apartment loans.

“Pricing competition is something that Fannie and Freddie push, because of their competitive advantage from the government wrap,” Berman said. He also noted that the banks aren’t strictly private either, in that banks have the advantage of a federal deposit guarantee to feed their capital base.

“The GSEs push other lenders when they are competing to tighten spreads and lower rates for borrowers,” Berman said. “So one thing that could well happen if the GSE lending caps are lowered is that the rates for borrowers will go up. So, the cost of producing and maintaining multifamily-rental housing would be higher for owners.”

Another housing expert who believes it would be a rash move to squash GSE activity in multifamily is Mark Willis, a senior policy fellow at the NYU Furman Center for Real Estate and Urban Policy.

“At this point in the cycle, I really think there is a lot of capital out there,” Willis said. “So, the real question goes back to if we have a recession, and the rest of the private sector pulls back from making these kind of mortgages, what counter-cyclical support would we like Fannie and Freddie to provide that is so helpful and was so helpful in the last recession? That is the question here that needs to be addressed.”

The combined GSE volume for 2015 was revised up from the original version.  


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