Fannie and Freddie

How to Profit Big from High-Cost Housing?

This is the current economic state of the largest voting demographic in our country (millennials), and one of the big reasons why President Biden has the lowest approval rating in history (tied with Jimmy Carter):

FMT has zero doubt that both democrats and republicans will be trying to win the largest segment of our population over and try to fan the flames of their discontent. But how?

Well, the United States is grappling with an acute housing affordability problem, and government solutions—particularly around elections—are likely to become significant talking points on the campaign trail.

Ironically, excessive government money printing and inflation have been the primary drivers behind the unaffordable housing market. Post COVID-19, excessive money printing and cheap money led to a surge in investment demand for housing, and to add insult to injury, inflation has now also driven interest rates and various housing costs substantially higher since 2022.

Consequently, the average age of a home purchaser today is now 50 years old, making affordability for younger generations generally out of reach. The ability to achieve the “American Dream,” especially for millennials (the largest demographic in the United States), poses a significant challenge for politicians. This issue has become a bipartisan concern.

The housing unaffordability issue has been exacerbated by the mortgage-backed securities (MBS) market, as banks exhibit little appetite for duration balance sheet risk. The regional banking crash and panic in early 2023 were triggered by banks holding long-term income securities that tanked as inflation heated up, causing impaired capital ratios and ensuing bank runs. The Federal Reserve intervened with its emergency BTFP facility in response.

Reduced bank demand for MBS, coupled with the government conservatorship of Fannie Mae and Freddie Mac, has diminished their influence in the markets, impacting liquidity and further complicating housing affordability.

The government conservatorship of Fannie and Freddie has increased housing unaffordability by widening the credit spreads on 30-year fixed-rate mortgages above the 10-year Treasury bond. Under typical economic conditions, the spread is 1.6% to 1.75%. However, due to the mentioned issues, the credit spread for mortgage rates has reached historically high levels, currently standing around 7%, instead of the typical 5.75% it would be at today.

This is a substantial drag on housing affordability.

The recent election of Sandra Thompson as FHFA head of housing with wide bipartisan support signals a potential shift with Fannie Mae and Freddie Mac. Her goal is to address affordability with “priorities that are tangible, impactful, and achievable.” One lever to achieve this is allowing the mortgage giants to bolster their on-balance-sheet purchase of MBS to lower credit spreads and borrowing costs for the housing consumer (what they were set up to do in the Great Depression).

Priscilla Almodova, elected as the new chief officer of Fannie Mae, emphasizes that the mortgage giants have been “rehabilitated,” “conservatorship was never meant to be forever,” and “someone will want to start taking victory laps.”

They are setting the stage for the release of Fannie Mae and Freddie Mac to public markets. If so, this will be the largest IPO in history.
With a combined capital of $110 billion, Fannie Mae and Freddie Mac now boast fortress-like balance sheets after years of retained earnings. The U.S. government’s ownership of warrants on these entities suggests substantial gains for them when they return to the public markets as heavily regulated utility-like companies.

The government could stand to gain around $100 billion on its warrants after dealing with their Senior Secured preferreds in the capital structure, contingent on the return of Fannie Mae and Freddie Mac to the public markets. The government could use these gains for the 435 Congressional Districts, which would equate to over $230 million for housing related investment in every district.

It’s not hard to imagine why this is gaining bipartisan support, and someone is going to want to take the credit for it.

There’s speculation that President Biden might officially initiate this process around his next State of the Union address in March, considering the pressing issue of affordable housing, his dismal approval rating, and its likely prominence in the upcoming campaign: “Make Owning Houses Affordable Again.”

If Biden doesn’t take this step, there’s a high probability (99%) that Trump will if elected. Trump faced obstacles in his previous term and ran out of time to complete the job. The pathway is clear for him to set Fannie and Freddie free now (letter is attached below on why he just ran out of time).

In my view, the return of Fannie Mae and Freddie Mac to their rightful owners is getting close. This move could make a significant impact on those positioned across the right parts of their capital structure, with the junior preferreds likely rising by 600% and 700%, respectively, on such an outcome.

Setting Fannie and Freddie free is the right thing for America, and it’s also essential for private property rights. Notably, politicians are set to compete for legacy and bragging rights by facilitating growth in the largest part of our economy—housing, currently trapped in high-cost limbo, and has a lot of young people pessimistic about owning a piece of the American Dream.

The largest IPO in United States in history is close.