The GSE Dilemma: Can We Privatize Without Disrupting the American Dream?

In discussions about the future of Fannie Mae and Freddie Mac, a critical question arises: Can the market truly function without the assumption of government backing for mortgage-backed securities (MBS)??The reality is that any move toward privatization will likely include an implicit, if not explicit, government guarantee. Without such backing, the exemplary market attributes we currently enjoy—tight spreads, deep liquidity, and lower mortgage rates—would be at risk.

Moody’s recently reinforced this concern, stating that absent legislation providing an explicit guarantee, the biggest risk to conservatorship exit is whether market participants continue to view MBS as government-backed [1]. If confidence wavers, MBS spreads will widen, raising mortgage rates and reducing credit availability.?

THE SCALE OF THE GSEs' INFLUENCE

Fannie and Freddie are?not just two players in the mortgage market—they are the mortgage market. Their influence extends beyond CRTs and into the?$7.2 trillion?MBS market, which functions?as an extension of U.S. government credit:

• Implicit Government Guarantee:?GSE MBS are effectively treated as "government-backed" despite lacking a formal guarantee.
• Institutional Holdings:?The?Federal Reserve and U.S. commercial banks hold trillions in agency MBS, reinforcing the system’s reliance on perceived government support.
• Preferred Stock Purchase Agreements (PSPAs):?The?Treasury's remaining PSPA commitment of $254 billion provides an explicit capital backstop, though it does not formally guarantee future MBS issuance.

The dominance of government-backed entities fundamentally shapes the mortgage market, influencing pricing and limiting the role of private-label MBS in ways that might not exist in a fully private system. While this reduces costs for borrowers and enhances liquidity, it also raises questions about long-term market distortions and risk allocation. But this is the reality we live in—Fannie and Freddie have become deeply embedded in the financial system, and their scale is inextricably linked to both economic stability and the American Dream of homeownership.

Any attempt at privatization?must carefully consider the path from here to there. The transition must be?deliberate and measured, recognizing that these institutions?aren’t just financial entities—they are core infrastructure?in housing finance. A misstep in execution could disrupt credit availability, increase mortgage rates, and create unnecessary instability in an already fragile housing market.

CAPITAL ADEQUACY & MARKET CONFIDENCE

Michael Bright’s recent commentary in American Banker correctly highlights the distortions caused by conservatorship, the GSEs’ expanding footprint, and the need for meaningful capital standards before any transition to privatization [2]. These are real concerns.

If the GSEs exit conservatorship with less capital than the market deems appropriate, we could see significant impacts on Credit Risk Transfers (CRTs)—wider spreads, repricing, and investor skepticism.

CRTs are effective in offloading some risk to private investors, but they still rely on a government backstop in extreme loss scenarios. This means taxpayers remain exposed to tail risks even after privatization.

Bright also suggests pragmatic changes to improve and expand private MBS market activity, including:

• Standardizing securitization practices?to enhance transparency and investor confidence.
• Encouraging private capital participation?through regulatory incentives.
• Developing robust risk-sharing mechanisms?to distribute mortgage credit risk more evenly.

Implementing these measures could strengthen the private MBS market, providing a more stable foundation for any future GSE reforms.

HOW MUCH CAPITAL?

Undercapitalization would drive uncertainty, higher mortgage costs, and instability in the private-label mortgage market.

The FHFA recently estimated that the GSEs face a $421 billion capital shortfall needed to withstand a severe downturn [3]. While there is broad consensus that a significant capital deficiency exists, the key question remains: is the market aligned on what constitutes "adequate" capitalization?

Some have suggested that the GSEs could gradually accumulate capital through retained earnings, but with a combined annual profit of approximately $25 billion, it would the better part of a decade to make meaningful progress—still leaving a substantial gap.

Given this reality, retained earnings alone won’t be enough. Any viable path forward will likely require a combination of capital retention, external stock issuance, and expanded risk transfers to private investors to reduce the GSEs’ reliance on government backing while ensuring sufficient financial stability.

Notably, some proposals have suggested privatizing one agency at a time to manage the transition more effectively. This phased approach could allow for better assessment of market reactions and adjustments as needed.

WHAT COMES NEXT?

The?real test of GSE reform?is not just capital adequacy—it’s?how to balance privatization with preserving the benefits the MBS market provides to Americans.

The challenge isn’t theoretical; it’s why?Fannie Mae and Freddie Mac have remained in conservatorship for over 16 years. Any transition must confront difficult trade-offs:

• How can privatization be structured to attract private capital while ensuring continued liquidity and affordability in the mortgage market?
• If market participants demand an implicit government backstop to maintain stability, is full privatization even possible—or will the GSEs remain in a quasi-public state indefinitely?
• Can the benefits of a well-functioning MBS market be maintained while shifting more risk to private investors?

These are not easy questions, and?the lack of clear answers is why policymakers have struggled to move forward. The tension between?privatization, market confidence, and housing affordability?is not easily resolved. But if reform is to happen, it must?acknowledge today’s realities and chart a responsible, well-structured path forward—one that strengthens the housing finance system without sacrificing the accessibility and liquidity that Americans rely on.

Footnotes:

[1] Moody’s Investors Service. (2025, February 10).?Federal National Mortgage Association and Federal Home Loan Mortgage Corporation: Conservatorship exit would likely reduce probability of government support of unsecured debt. Retrieved from?Moody’s.

[2] Bright, M. (2024).?GSE reform should focus on preserving the private market, not just ending conservatorship.?American Banker.?Retrieved from?American Banker.

[3] HousingWire.?(2024).?FHFA sounds the alarm over GSEs' ability to absorb losses.?HousingWire. https://lnkd.in/e2acjfuE.