Ever since the federal government placed Fannie Mae and Freddie Mac in conservatorship four years ago, policymakers and stakeholders have struggled with the question of what to do with these challenged but fundamental components of the nation’s mortgage finance system. Most generally agree that the two government-sponsored enterprises (GSEs) can’t survive in their present form. Finding the right fix, however, is anything but simple.

Fannie’s and Freddie’s multifamily lending may make up a smaller portion of their portfolios than their single-family businesses, but the GSEs’ multifamily programs have been quite successful. They have default rates of less than 1 percent and have produced roughly $7 billion in profits for the federal government since being bailed out.

But the gravity of the problems with Fannie’s and Freddie’s single-family mortgage financing programs is overshadowing this proven multifamily track record. And as GSE reform evolves, a single-family focus could cost the apartment industry a critical source of financing, undercutting its ability to provide quality housing for the nearly 100 million Americans who rent.

Whither Alternative Financing?

From the beginning of 2008 through the third quarter of 2011, the GSEs provided $144 billion in financing to the multifamily industry. This represents roughly 55 percent of the debt accessed by the industry, with traditional financing sources such as banks and life companies providing the remaining capital. This means that since 2008, one in every two apartments would have been unable to secure construction financing or refinance existing loans without the GSEs.

Some argue that alternative sources of capital could fill the financing gap if the GSEs were to exit the marketplace. However, this scenario is unlikely, given various market constraints. Banks are limited by capital requirements and continue to work through troubled balance sheets resulting from the stagnant economy. Life insurance companies, which have historically provided less than 10 percent of the industry’s capital, lend primarily for newer, high-end properties and are somewhat inconsistent, entering and exiting the multifamily market based on changing investment needs and economic conditions. Moreover, the private-label CMBS market is unlikely to return to the volume and market share it reached a few years ago. Finally, the Federal Housing Administration, which ramped up its multifamily financing activities through the housing downturn, has exceeded its lending capacity.

Maintaining adequate liquidity in the debt markets will be more critical in the future as America increasingly relies on rental housing. The apartment industry needs to build an estimated 300,000 units a year to meet expected demand. Yet, we started just 167,400 in 2011, barely enough to replace the units lost to demolition and obsolescence. Without some degree of government credit support, the industry’s supply–­demand imbalance will become more acute, driving up the cost of rental housing.

A Stand-alone Proposal

With private capital sources unable to fully meet the apartment industry’s needs, it’s important to find a solution to the GSE question that will ensure continued access to capital. At the same time, the solution must be flexible enough to allow the private capital market to assume a larger financing role.

Given the GSE multifamily programs’ record of success, the National Multi Housing Council (NMHC) believes such a solution could involve spinning out Fannie’s and Freddie’s multifamily businesses into stand-alone and independently capitalized entities, creating a framework that would maintain liquidity in the market. Key elements of such a proposal would include:

• Establishing new, stand-alone entities. Each company’s multifamily platform would need to transfer to new, successor entities. Taxpayers would be compensated for the value of Fannie’s and Freddie’s holdings.

• Retaining a federal credit guarantee. This would be tied to the security, a necessary provision to attract global investors. However, unlike today, neither the GSE-successor entities nor their shareholders would be eligible for a guarantee, forcing them to absorb all losses. Furthermore, the credit guarantee would be priced to prevent the GSE successors from receiving capital at preferential rates and crowding out private-debt providers.

• Setting up critical taxpayer protections. The GSE-successor entities would be obligated to pay a fee to the government covering the entire cost of the guarantee. The entities also would have to hold significant levels of risk-based capital. And last but not least, the entities would be required to retain risk in each mortgage to support prudent underwriting.

• Empowering a strong regulator. This entity would be charged with establishing and enforcing effective capital standards and reserves, as well as monitoring and assessing performance to ensure a competitive private-debt market.

The NMHC is working to further develop this proposal with input from key stakeholder groups. The end goal is to provide lawmakers and regulators with a road map for addressing the multifamily sector’s capital concerns and ensuring that adequate liquidity remains available as more wholesale GSE reform is enacted. A complete outline of the proposal is available at www.nmhc.org/goto/60819.

Doug Bibby is president of the Washington, D.C.–based National Multi Housing Council.