AEI’s Charts of the Week: History Repeats Itself with the (Quiet) Battle for Subprime Loans Among Government Mortgage Giants

As in the 1990s and 2000s, an unseemly battle is underway among Fannie, Freddie, and FHA for subprime share in the low- and moderate-income first-time homebuyer loan market. While the battle is being conducted more quietly this time, it is hard fought none the less.

Click here to access the entire Housing Market Indicators slide presentation for February 25, 2019.

Let’s start with Fannie and Freddie, which are destined by affordable housing mandate to be locked in a perennial battle for loans that meet the mandate.

The charts below indicate that Fannie Mae’s risk index continues to outpace Freddie Mac’s. Fannie’s purchase MRI in Nov. 2018 was 1.5 ppts (or 22%) higher than Freddie’s. Interestingly, this risk pick-up has not translated into any meaningful market share gains for Fannie. While its share has been volatile, it has averaged around 58-61% for each November since 2013.

The next chart provides a closer look at the risk distribution of Fannie and Freddie, which reveals that while Freddie has loosened underwriting moderately, Fannie has been more aggressive.  With Freddie reluctant to engage in a race to the bottom, Fannie is free to set its sights on FHA.  Here their unhealthy competition is moving both out the risk curve.  The share pickup and loss by risk bucket for Fannie, Freddie, and FHA shows that Fannie is increasingly competing with FHA for loans with a risk score between 12-24% (loans with a risk score >12% are subprime), as it loses lower risk loans rated <=8% (prime loans are rated <=6%). This segment currently accounts for 41% and 38% of Fannie and FHA’s business respectively.  FHA is replacing lost lower risk business with much higher risk loans, those with an MRI of greater than 32%.  Unhealthy indeed for both Fannie and FHA (and for the home buyers, particularly first-time buyers).

This last chart shows an interesting dynamic with respect to loan rates. As the GSE’s business has grown in the high risk >95 CLTV purchase loan segment, Fannie has been holding the clear advantage over Freddie with a market share of 75-95% (Fannie’s share of all GSE purchase business is currently less than 60%).  Interestingly, with Fannie in the driver’s seat, it has been charging higher loan rates (offering lower loan prices) on a risk-adjusted basis.  As already noted, Fannie has been poaching these loans from FHA.  This is because FHA does not price for risk.

Is this a case of Fannie may and Freddie won’t?  In 2017, Freddie missed some of its single-family housing goals, while Fannie exceeded performance for the same goals.  In the 1990s and 2000s there was a similar pattern with Freddie missing some goals and generally achieving lower levels than Fannie.  Based on the above analysis, it appears likely that Freddie will again miss some of its single-family housing goals for 2018 (performance not yet released by FHFA), while Fannie exceeded performance for the same goals. As we have been saying for some time, Freddie’s greater aversion to leverage during a seller’s market helps affordability, not harms it.  Fannie should take notice.


Edward J. Pinto

By Edward J Pinto

American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s Center on Housing Markets and Finance.  Along with AEI resident scholar Stephen Oliner, Pinto is creator of the Wealth Building Home Mortgage, a new approach to home finance designed to serve the twin goals of providing to a broad range of homebuyers – including low-income, minority, and first-time buyers – with a more reliable and effective means of building wealth than currently available under existing policies, while maintaining buying power similar to a 30-year loan.  He is currently researching approaches to increase the supply of market rate economical apartments for hourly wage earners. Active in housing finance for 45 years, he was an executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done ground breaking research on the role of federal housing policy in the 2008 mortgage and financial crisis.  He is now conducting research on the current house price boom that began in 2012. Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.