US Housing Reform and the Future of CRTs

Credit risk-transfer securities (CRTs) have made the US mortgage market safer by shifting default risk from taxpayers to private investors. The latest attempt to overhaul the housing finance system isn’t likely to change that.

A recent memo from President Donald Trump directed the US Treasury to come up with a plan that would end government control of Fannie Mae and Freddie Mac, and possibly return them to private hands over the next few years. The government took over the companies after they suffered massive losses in 2008.

At this point, the memo is just a plan to make a plan. Even so, it has some investors worried that privatization could end the government guarantee of coupon and principal payment that the bonds issued by Fannie and Freddie carry. That would depress prices of existing mortgage-backed securities and likely hurt market liquidity. Some also worry that it might put the future of the CRT market in doubt.

We don’t think that’s likely. CRTs are already doing one of the things that the reformers in the White House and Congress say they want done: insulating taxpayers from losses.

Sharing Risk, Reaping Rewards

Fannie and Freddie began issuing CRTs in 2013. Like typical agency bonds, CRTs pool thousands of different mortgages into a single security, and investors receive regular payments based on the performance of the underlying loans. But there’s a key difference: CRTs carry no government guarantee of principal and coupon payments. If a large number of the loans default, private investors in these securities would be first to absorb losses.

By building a layer of private capital into Fannie and Freddie’s capital structure, these securities have been successful in shoring up the market and getting US taxpayers off the hook for losses. They’ve also been popular with investors because they offer relatively high yields and floating interest rates, which offer protection in rising-rate environments.