If we look back to the subprime mortgage crisis of 2008, which prompted a worldwide financial crisis, much has changed. However, a lack of competition in the US secondary mortgage market is prompting concern for the future of homeowners struggling with everyday costs. This has prompted Freddie Mac, the US government-sponsored mortgage finance agency, to file an interesting proposal with the Federal Housing Finance Agency regulator.

 

Is Freddie Mac about to enter the secondary mortgage market?

 

Referred to as the "secondary mortgage market" in the US, this is perhaps best known as home equity loans. At a time when US homeowners are struggling, a recent report suggested that there is more than $32 trillion of equity tied up in US homes. However, a lack of competition and increased regulation since 2008 has seen a massive reduction in home equity loans.

 

In 2007, there were $700 billion in outstanding home equity loans; today, that figure is just $350 billion. Over this period, the average house price in the US has increased by more than 70%, but homeowners are still finding it difficult to release equity.

 

Alternative finance companies trying to fill the void

 

The ongoing reduction in home equity loans is replicated across the major US banks, with Bank of America reducing its home equity loan portfolio from $150 billion in 2009 to just $25 billion. Figures from 2022 show that more than 50% of equity loans were originated from what are deemed "non-traditional lenders."

 

Unlike the leading banks in the US, non-traditional lenders are unable to hold these debts on their balance sheets. Therefore, unless they can sell-on or outsource (securitise) them to third parties such as Freddie Mac, capacity will always be limited.

 

How would Freddie Mac change this situation?

 

Official forecasts suggest that if Freddie Mac were to get the go-ahead to enter the secondary market, this could potentially release up to $1 trillion into homeowners' pockets over the summer. By the autumn, this could be headed towards $2 trillion, a potential game changer for the US economy. Would this increase government or national debt?

 

As these home equity loan purchases by Freddie Mac would be asset-backed, with a combined first mortgage and second mortgage maximum loan-to-value ratio of 80%, they would not add debt (or significant risk) to either the government or the nation. Currently, the loan-to-value ratio of the Freddie Mac mortgage portfolio is 52%, leaving scope to release an additional $980 billion.

 

Securitising secondary mortgages

 

Under the proposals, Freddie Mac would only take on secondary mortgages where it holds the original mortgage, allowing the two loan-to-value ratios to be combined. Assuming Fannie Mae and Ginnie Mae follow suit, this could increase the secondary home equity loan market to around $3 trillion.

 

Another important benefit would be a significant increase in competition – attracting institutions looking to securitise mortgage loans - thereby reducing the cost to borrowers. The potential to release trillions of dollars to US homeowners and the knock-on effect on the economy would be very welcome in these difficult times. However, if there is one fly in the ointment, could this also place upward pressure on inflation?

 

Summary

 

When you consider the potential impact of this move on the secondary mortgage market, with no added cost to the government or the country, this seems like a no-brainer. In the weeks and months ahead, we will no doubt see more details, forecasts, and reports, but aside from potentially creating new fuel for inflation, it's difficult to see any real downside.

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