Two mortgage industry trade bodies, Community Home Lenders of America and the Independent Community Bankers of America, wrote to the regulator of Fannie Mae and Freddie Mac last week. In their letter, they told William Pulte, director of the Federal Housing Finance Agency (FHFA), that he could, at a stroke, cut mortgage rates by 30 basis points, which is 0.3%.
On Oct. 23, Freddie Mac reported that the average weekly rate for a 30-year, fixed-rate mortgage was 6.19%. A 30-basis-point reduction from that would bring that average down to 5.89%.
Could it be that simple?
Trade Bodies' Proposal
The trade bodies proposed that the FHFA should alter its rules to allow Fannie and Freddie to buy more mortgage-backed securities (MBS), the financial instruments whose yields determine mortgage rates.
In other words, Fannie and Freddie would buy its own product.
The extra demand in the MBS market would, given a constant supply, push up MBS prices. And, because bond yields and prices move inversely, that should lower mortgage rates. The bodies estimated that this "could reduce mortgage rates by 30 basis points or more."
The rule would kick in when 30-year mortgage rates were more than 170 basis points above the 10-year Treasury.
For example:
- 10 Year Treasury: 4%
- 30-year fixed rate: 6%
- Spread: 2% (200 basis points)
- The rule would kick in until Fannie and Freddie buy $300 billion in MBS or mortgage rates hit 5.7% (170 basis points above the 10-year)
The current spread is 219 basis points.
To see if it would work, we have to understand what Fannie and Freddie do in the first place.
What Fannie and Freddie do
The Stanford Institute for Economic Policy Research (SIEPR) provides a masterly overview of Fannie and Freddie's roles, summarized here:
- Fannie Mae and Freddie Mac enable easier access to low-rate mortgages.
- Their customers are lenders. They set nationwide guidelines by which lenders approve mortgages.
- Lenders pay a guarantee fee, which is passed to borrowers. Borrowers also pay PMI.
- Lenders sell these guaranteed loans as mortgage-backed securities to investors.
- This approach has cut mortgage rates and made home loans more accessible.
Why Mortgage Rates Move
Mortgage rates are largely determined by the yield on a type of bond, the mortgage-backed security or MBS. Given a constant supply, the more investors buy MBSs, the higher their price rises and the lower their "yield," which is the interest rate the investor receives, falls. It's a mathematical inevitability that all bond prices and yields move inversely.
You'll often read that mortgage rates have a close relationship with the yield on another type of bond, the 10-year U.S. Treasury note. And, indeed, mortgage rates often shadow that bond yield.
However, that's not because those rates are tied to that bond. It's just that the same things that push 10-year Treasurys up and down affect MBSs and mortgage rates similarly.
The Spread
And sometimes the relationship between the two types of bonds drifts apart. That increases the "spread," which is the difference between the yields on each.
There's always a spread because U.S. Treasury securities are regarded as the safest form of investment, and investors settle for a lower yield than on MBSs, which are a little less safe.
"The spread between the 30-year fixed rate mortgage and the 10-year Treasury is historically wide today; as of October 17th it was 222 basis points," said the trade bodies' letter. " ... The spread has been elevated over the normative spread of 140-170 basis points since 2022, when the Federal Reserve suspended its MBS purchases (that it had been undertaking as needed since 2008)."
Caveats
The trade bodies' proposal may sound like a no-brainer. But, as always, it's not that straightforward.
The government had to put Fannie and Freddie into conservatorship in 2008 because the two enterprises had too many questionable MBSs on their balance sheets, putting them at risk of going bust.
"Commentators have ... raised the possibility that Fannie and Freddie could once again purchase more of their own MBS as investments, as they did before the financial crisis," says the SIEPR. "Currently, the PSPAs [senior preferred stock purchase agreements, an integral part of the conservatorship] impose limits on the size of these portfolios.
The SIEPR argues that loosening restrictions could bring down mortgage rates but puts more risk on Fannie and Freddie.
Is it worth that additional risk for a fairly modest 30-basis-point reduction in mortgage rates? After all, they've already dropped an awfully long way (160 basis points) all on their own since they peaked at 7.79% during the week of Oct. 25, 2023.
Luckily, you and we don't have to decide. It's the government's call.
