On Raising the G-Fee

One of the eight GSE reform bills to be debated tomorrow afternoon is aimed at making Fannie and Freddie charge a more appropriate fee for the guarantee they provide (a “g-fee”). The bill, introduced by Rep. Neugebauer (R-TX), instructs FHFA to determine what the market would charge as a g-fee if they were setting the price. Put another way, if Fannie and Freddie were private companies with no government support, what fee would they charge to guarantee payment on mortgage-backed securities to investors? Certainly higher than their current fee, which is subsidized. FHFA would be required to gradually increase the GSE g-fee to their determined new rate over two years.

A core value of this is decreasing government exposure to housing market risk. Over time this would increase the cost of doing business with the GSEs and create room for private capital to be more competitive with the government agencies. Plus, the meantime the GSEs would be collecting more revenue, which could be put back towards the cost of bailing them out.

So how much should the fee go up? There are a range of potential answers to the question and it all depends on the approach to estimating the fee and what factors are considered. So for the sake of simplicity, I would point to the CBO.

In a paper last year, the Congressional Budget Office outlined it’s budget treatment of Fannie and Freddie. Part of the report estimated the subsidy cost to the government of being the backstop of the GSEs. For example, CBO estimated that the cost of providing a guarantee to Fannie and Freddie cost $291 billion in 2009. This meant the GSEs would have to charge 440 basis points more than usual if they were to operate the same way but be a fully private company without the government backstop.

The report estimated that the GSEs should charge 150 basis points (or 1.5%) more in their g-fee for 2011 in order to account for the subsidy, 120 basis points for 2012, and 110 basis points for 2013 (see table 2 on page 8). Those are significant subsidies. FHFA will have to determine if it agrees with the CBO assessment and then be bold.

But what are the chances of this? FHFA acting director DeMarco is good at his job, but he is still a bureaucrat. A way to remedy this would be to amend the Neugebauer bill to place a minimum increase in the g-fee. If you total the subsidy cost estimated in the CBO report for 2011 through 2019, the average annual subsidy cost is 55 basis points. That could serve as good reasoning for a minimum increase in the g-fee.

For those that argue this is too high, remember that the subsidy for the GSEs is big, and it would be phased in over two years. Plus, FHFA may determine the rate should be higher than this; 55 basis points would just be a minimum. Some analysis by Chris Papagianis published over at SeekingAlpha in February found that the g-fee should probably go up 75 to 100 basis points.

For more, see this working paper based on my February testimony before the House Financial Services Capital Markets Subcommitee.