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Freddie Mac and its Biden regulator want to guarantee second mortgages. What could possibly go wrong?


The Editorial Board

May 5, 2024 4:46 pm ET


Housing godzillas Fannie Mae and Freddie Mac are threatening the countryside again, and better hide the children. It’s not enough that taxpayers stand behind their $7.5 trillion in mortgages. Now Freddie wants taxpayers to back second mortgages—i.e., de facto consumer loans. What could go wrong?

Higher interest rates have slowed the housing market and reduced cash-out refinancing following the pandemic boom. This has crimped the businesses of mortgage lenders and Fannie and Freddie, the government-sponsored enterprises (GSEs) that buy and guarantee home loans. At the same time, Americans are paying more to borrow for cars and other things.

Enter Freddie, which wants to counter higher interest rates by guaranteeing closed-end second mortgages. Similar to cash-out refinancing, second mortgages allow homeowners to tap equity in their home. The big difference is homeowners don’t have to refinance their entire outstanding loan at a new interest rate.

As the Freddie and Fannie regulator, the Federal Housing Finance Agency (FHFA), explains, “only the smaller, second mortgage would be subject to the current market rate, as the original terms of the first mortgage would remain intact.” Homeowners who bought homes or refinanced during the pandemic wouldn’t have to give up their uber-low rates to tap equity.

The FHFA offers the example of a homeowner with an original $150,000 loan and a current unpaid balance of $120,000. By the agency’s calculations, he would save $136.77 a month and $112,797 in total interest by borrowing $30,000 with a second mortgage versus a cash-out refinancing.

It gets better. Second mortgages typically carry lower interest rates than consumer loans. So borrowers could consolidate their auto and personal loans into a lower-interest second mortgage. If Freddie were to guarantee the second mortgage, its implicit government backstop would further reduce their interest rates.

Freddie and home lenders would profit from a new line of business. Consumers—at least the fortunate ones who bought homes before prices skyrocketed and who have built up equity—would have more spending power.

Bank of America research team estimates that homeowners could extract about $1.8 trillion in equity if Fannie copies Freddie’s idea. That’s more than three times as much as the $512 billion in outstanding second loans and home equity lines of credit. By increasing market liquidity, the GSEs would encourage more lenders to make second mortgages.

As usual, the likely losers would be taxpayers. One risk is that home prices fall, causing some homeowners with second mortgages to default. An equity buffer helps reduce defaults, which is one reason foreclosure rates remain near record lows. A reduction in equity would make defaults and foreclosures more likely.

Former Democratic Rep. Brad Miller testified in a 2015 hearing on the 2008 financial crisis that “the subprime mortgage model was to lend to people who already owned their own homes—70% were refinances and had a lot of equity in their home—and the mortgages were designed to catch them in a cycle of borrowing and borrowing again.”

He blamed banks for being greedy, but they were merely responding to incentives created by the government and Fannie and Freddie. If Fan and Fred buy and guarantee second mortgages, this will also create new risks in the financial system.

If homeowners with higher credit scores consolidate their consumer loans into second mortgages, riskier borrowers would make up a larger share of bank portfolios. Banks would then hold fewer high-performing loans to offset losses from those that default, which would increase the risk of failures. And guess who stands behind the big banks? Taxpayers.


The FHFA last month opened Freddie’s second mortgage plan for public comment. But unlike agency rules, the plan doesn’t have to undergo a formal rule-making that includes a cost-and-benefit analysis. Freddie can automatically adopt the plan within 60 days unless the agency vetoes it.

Fannie and Freddie are supposed to advance their mission of making housing more affordable for low- and middle-income households. Freddie’s second-mortgage plan won’t. It will help those who own homes and have already benefitted tremendously from the runup in housing prices since the pandemic.

The FHFA is playing politics here to boost consumer spending and the housing market in an election year. But it’s doing so by putting taxpayers on the hook for countless billions more in mortgage debt less than a generation after taxpayers had to bail out Fannie and Freddie. Godzilla always returns for another sequel, more dangerous than ever.


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