The Prospector spoke to Douglas Duncan, the senior vice president and chief economist at the US Federal National Mortgage Association, which is commonly known as Fannie Mae. It is an organisation founded in the 1930s in response to the Great Depression, but is now a private company which acts in the mortgage market to help lenders maximise their borrowing capacity by securitising mortgage debt and issuing residential mortgage-backed securities.
Duncan is responsible for managing Fannie Mae’s Economics & Strategic Research Group and the conversation covered a broad spread of subjects. What follows is the final part of the interview—the previous sections can be found here on this site.
Jay Elwes: What do you think the future holds for Fannie Mae? Because I know it has been the subject of discussion on Capitol Hill.
Doug Duncan: All decisions about the future of Fannie Mae are in the hands of Congress and the administration. One way to think about the issue is to consider what policymakers might need to consider when making decisions about reform. Maybe the first decision that you have to make is: do you want to keep the 30-year fixed-rate, level payment, self-amortising mortgage? And if so, what type of infrastructure is necessary to support it?
This is basically about 90 per cent of the US mortgage market. If you determine you want to a keep long-term fixed rate mortgage, then that mandates a certain set of structures such as the TBA market (To Be Announced) which allows lenders to sell forward into the market a commitment to deliver mortgages with specific characteristics at some future date. And that only exists because the enabling structure is supported legislatively and in a regulatory manner. If you decide to accept that, then you know some of the structures that will have to exist and you know that many of those are related to the structures of Fannie Mae and Freddie Mac. If you decide what structures have to exist, then you can decide who owns them, whether private or the government or a combination of things. Once you’ve decided who is going to own them, then you will have decide how much capital they are going to have to bring to the table. And that will lead you to an allocation of the role of the private sector versus the role of the public sector.
When considering the public sector piece, you’ll need to determine if it’s role should be explicit. And if you decide it should be explicit, it should be priced, and if it’s priced, you must decide how remote to make it from the taxpayer. All of those decisions are related decisions that will lead you, ultimately, to some policy for reform. That discussion is more seriously under way now that Senators Corker (R-Tenn.) and Warner (D-Va.) on the Senate Banking Committee have developed a proposal. Both the majority and minority leaders of the committee are considering the proposal as a starting point to develop their own legislation. The House has already staked out a position, and is simply waiting for the Senate to come to a decision, before starting the negotiations on where things will ultimately end up.
Timing on that? I think it’s unlikely to happen before the mid-term elections. And then the likelihood of it happening before the next presidential election? I think most folks watching the situation are suggesting that it is less than 50/50 that it will happen before the next presidential election. I have enough trouble forecasting interest rates, I’m not forecasting political odds—it’s not really my bailiwick!
But that’s kind of the scenario you have to run through if you want to figure out where you want to end up in policy. And I think there is a broad consensus that having a 30-year fixed-rate mortgage in place is something that public policy will want to support. So it’s from that starting point that I think you’ll see things unfold.
JE: How do you see emerging markets at present?
DD: China is interesting. One thing we have been discussing with people is the decision by China, which we think is serious and will be sustained, to shift from a more investment-focused economy to a more consumption-focused economy.
JE: Can they do that?
DD: Well, we will see. They have been very clear about that being their intent. That will have a number of implications for global capital flows, and for real interest rates across various national boundaries. And certainly our view is that will, in some sense, mean higher and longer term real interest rates in the US. Being focused on housing, we’re thinking about the potential impact of that over the coming decade or so.
JE: So you think that appetite for Treasuries will dip on account of the Chinese having less of a current account surplus to store in bonds?
DD: Yeah, we believe that. And the question is—are there others that would pick that up? And how would the terms change? And, of course, one of the issues for the US is that we have been running large deficits, which have required global funding. This will be an issue we will be having for some years.
JE: So the question is whether the Chinese government can enact political reform as well as economic reform. Because it seems that really what the Chinese are waiting for is a consumer revolution, and for that to happen the Chinese government is going to have to be much less controlling of capital, and also of markets. Do you think it’s likely to do that?
DD: Well, I believe they have made a serious statement that they intend to, but I don’t believe that it is going to be smooth. If you think about that, one of the ways that would be enacted is to raise wage rates. And if they have to raise wage rates to increase consumption, then that will change the terms of trade for others who compete with them. US manufacturers are looking at that as a shift in the relative wage rate in the favour of US workers. That is not likely to happen suddenly. It will take some time. But it is another one of the implications.
Duncan is responsible for managing Fannie Mae’s Economics & Strategic Research Group and the conversation covered a broad spread of subjects. What follows is the final part of the interview—the previous sections can be found here on this site.
Jay Elwes: What do you think the future holds for Fannie Mae? Because I know it has been the subject of discussion on Capitol Hill.
Doug Duncan: All decisions about the future of Fannie Mae are in the hands of Congress and the administration. One way to think about the issue is to consider what policymakers might need to consider when making decisions about reform. Maybe the first decision that you have to make is: do you want to keep the 30-year fixed-rate, level payment, self-amortising mortgage? And if so, what type of infrastructure is necessary to support it?
This is basically about 90 per cent of the US mortgage market. If you determine you want to a keep long-term fixed rate mortgage, then that mandates a certain set of structures such as the TBA market (To Be Announced) which allows lenders to sell forward into the market a commitment to deliver mortgages with specific characteristics at some future date. And that only exists because the enabling structure is supported legislatively and in a regulatory manner. If you decide to accept that, then you know some of the structures that will have to exist and you know that many of those are related to the structures of Fannie Mae and Freddie Mac. If you decide what structures have to exist, then you can decide who owns them, whether private or the government or a combination of things. Once you’ve decided who is going to own them, then you will have decide how much capital they are going to have to bring to the table. And that will lead you to an allocation of the role of the private sector versus the role of the public sector.
When considering the public sector piece, you’ll need to determine if it’s role should be explicit. And if you decide it should be explicit, it should be priced, and if it’s priced, you must decide how remote to make it from the taxpayer. All of those decisions are related decisions that will lead you, ultimately, to some policy for reform. That discussion is more seriously under way now that Senators Corker (R-Tenn.) and Warner (D-Va.) on the Senate Banking Committee have developed a proposal. Both the majority and minority leaders of the committee are considering the proposal as a starting point to develop their own legislation. The House has already staked out a position, and is simply waiting for the Senate to come to a decision, before starting the negotiations on where things will ultimately end up.
Timing on that? I think it’s unlikely to happen before the mid-term elections. And then the likelihood of it happening before the next presidential election? I think most folks watching the situation are suggesting that it is less than 50/50 that it will happen before the next presidential election. I have enough trouble forecasting interest rates, I’m not forecasting political odds—it’s not really my bailiwick!
But that’s kind of the scenario you have to run through if you want to figure out where you want to end up in policy. And I think there is a broad consensus that having a 30-year fixed-rate mortgage in place is something that public policy will want to support. So it’s from that starting point that I think you’ll see things unfold.
JE: How do you see emerging markets at present?
DD: China is interesting. One thing we have been discussing with people is the decision by China, which we think is serious and will be sustained, to shift from a more investment-focused economy to a more consumption-focused economy.
JE: Can they do that?
DD: Well, we will see. They have been very clear about that being their intent. That will have a number of implications for global capital flows, and for real interest rates across various national boundaries. And certainly our view is that will, in some sense, mean higher and longer term real interest rates in the US. Being focused on housing, we’re thinking about the potential impact of that over the coming decade or so.
JE: So you think that appetite for Treasuries will dip on account of the Chinese having less of a current account surplus to store in bonds?
DD: Yeah, we believe that. And the question is—are there others that would pick that up? And how would the terms change? And, of course, one of the issues for the US is that we have been running large deficits, which have required global funding. This will be an issue we will be having for some years.
JE: So the question is whether the Chinese government can enact political reform as well as economic reform. Because it seems that really what the Chinese are waiting for is a consumer revolution, and for that to happen the Chinese government is going to have to be much less controlling of capital, and also of markets. Do you think it’s likely to do that?
DD: Well, I believe they have made a serious statement that they intend to, but I don’t believe that it is going to be smooth. If you think about that, one of the ways that would be enacted is to raise wage rates. And if they have to raise wage rates to increase consumption, then that will change the terms of trade for others who compete with them. US manufacturers are looking at that as a shift in the relative wage rate in the favour of US workers. That is not likely to happen suddenly. It will take some time. But it is another one of the implications.
