Reimagining the U.S. Housing Finance System: The Fannie-Freddie Merger and Its Systemic Implications

The U.S. housing finance system stands at a crossroads. For over a decade, Fannie Mae and Freddie Mac have operated under federal conservatorship, their existence a relic of the 2008 financial crisis. Now, with the Trump administration's renewed push for privatization and Bill Ackman's high-profile advocacy for a merger, the conversation has shifted from theoretical reform to actionable strategy. This article examines the systemic risks embedded in the current structure, the potential benefits and pitfalls of a Fannie-Freddie consolidation, and what this means for investors navigating a market poised for transformation.

The Legacy of Conservatorship: A System in Perpetual Stasis

Since 2008, Fannie Mae and Freddie Mac have been shielded by the Federal Housing Finance Agency (FHFA) and propped up by a $340 billion Treasury stake in senior preferred shares. While this arrangement stabilized the mortgage-backed securities (MBS) market during the crisis, it also created a dependency that has stifled innovation and distorted risk incentives. The GSEs' implicit government guarantee allowed them to borrow at near-Treasury rates, a subsidy that critics argue inflated housing prices and encouraged speculative lending practices.

The 2008 crisis revealed the fragility of this model. Fannie and Freddie's combined $7.5 trillion in assets—largely backed by speculative MBS portfolios—posed a systemic threat when the housing bubble burst. The subsequent conservatorship reforms, including stricter capital requirements and reduced investment portfolios, mitigated some risks but did not address the root issue: the GSEs' hybrid public-private structure.

The Case for Merger: Efficiency vs. Systemic Risk

A merger between Fannie Mae and Freddie Mac, as proposed by Ackman and others, aims to streamline operations and reduce administrative costs. The FHFA estimates a merged entity could save up to $15 billion annually, creating a more unified risk profile and enhancing MBS market liquidity. However, this consolidation raises critical questions about systemic risk.

1. Capital Requirements and Privatization Pathways
As of Q1 2025, Fannie Mae is $33 billion short of its capital requirements, while Freddie Mac is $162 billion short. The GSEs rely on stockpiling earnings to meet these thresholds—a process that could take years. Faster solutions, such as IPOs or private capital infusions, risk diluting the Treasury's stake or introducing private interests that may prioritize profit over housing affordability.

2. The Treasury's Preferred Shares: A Double-Edged Sword
The Treasury's $340 billion in senior preferred shares creates a complex web of incentives. Converting these shares to common equity could unlock value for taxpayers but would require congressional approval. Retaining the stake risks perpetuating the GSEs' reliance on government support, while forgiving part of the obligation—though politically contentious—could accelerate privatization.

3. Market Implications: Rates, Liquidity, and Affordability
Removing the implicit government guarantee would likely increase mortgage rates. Economists Jim Parrott and Mark Zandi estimate rates could rise by 0.43–0.97 percentage points, adding $730–$1,670 annually to the average borrower's costs. This could dampen home sales, slow price appreciation, and strain first-time buyers. Conversely, a privatized GSE with a transparent capital structure might attract institutional investors, stabilizing the MBS market and fostering innovation in mortgage products.

Historical Precedents: Lessons from the Past

The 2008 crisis offers a cautionary tale. Despite warnings from the George W. Bush administration and the Federal Reserve, congressional leaders dismissed calls for reform until the GSEs teetered on the brink of collapse. The belated conservatorship reforms underscore the importance of proactive governance. A merger, if executed without addressing capital adequacy and risk management, risks repeating this pattern.

The Federal Home Loan Bank (FHLB) system's recent scrutiny further highlights systemic vulnerabilities. Like Fannie and Freddie, the FHLBs have been criticized for distorting their mission for private gain. The FHFA's 2023 report on the FHLB system reflects a growing recognition that GSEs must align with their congressionally defined public missions to avoid future crises.

Investment Implications: Navigating the Transition

For investors, the Fannie-Freddie merger presents both opportunities and risks. Here's how to position your portfolio:

1. Hedge Against Rate Volatility

Mortgage rates are projected to decline to 6.3% in 2025 and 6.2% in 2026, but privatization could reverse this trend. Consider long-duration MBS from the merged GSE or affordable housing projects to hedge against rising rates.

2. Favor Non-Bank Lenders

Non-bank lenders with strong securitization partnerships may benefit from a privatized GSE's streamlined risk assessment. Prioritize firms with low capital charges for MBS holdings.

3. Monitor Regulatory Developments
FHFA Director William Pulte's cautious approach suggests a phased transition. Track FHFA rulemaking and Treasury Department statements for clues on privatization timelines.

Conclusion: A Delicate Balance

The Fannie-Freddie merger is not a panacea but a critical step toward modernizing the U.S. housing finance system. While it could reduce systemic risk by creating a more resilient MBS market, it also introduces new challenges, particularly around affordability and market stability. Investors must weigh the potential for lower rates and operational efficiency against the risks of higher borrowing costs and regulatory uncertainty.

As the Trump administration pushes for privatization, the housing market's next chapter will be defined by how policymakers balance public mission with market forces. For now, the key takeaway is clear: the GSEs' future is no longer a distant debate—it's an unfolding reality with immediate implications for every corner of the real estate and financial sectors.