Goodbye to Fannie and Freddie

The Obama administration and the Treasury Department have decided that Fannie Mae and Freddie Mac — the public-private housing finance model in place for the past four decades – will come to an end, although they pledged to continue backing the agencies’ existing obligations. “The GSE (government-sponsored enterprise) model is dead,” an Obama administration official said.  The Treasury Department is currently working on three broad options for overhauling the mortgage lending system, but will let Congress make the final decision.  The government bailouts of Fannie and Freddie have cost taxpayers nearly $150 billion.

Obama administration officials have emphasized areas of agreement with Republicans, stressing that they favor a system that is less dependent on government support.  Approximately 90 percent of new mortgages are currently backed by Fannie, Freddie or other federal agencies.  The move pleased Republicans, who have long criticized the mortgage companies. “I’m encouraged to see the administration included a number of reform ideas that track closely with my own,” Representative Scott Garrett (R — NJ) said.  Garrett heads the House Financial Services subcommittee, which oversees Fannie and Freddie.  Representative Randy Neugebauer (R – TX), said he was pleasantly surprised by the focus on restoring the mortgage-backed securities market issued without the government’s guarantee.  Debate over the future of the mortgage giants is often contentious on Capitol Hill.  Republicans consistently criticized last year’s Dodd-Frank financial-overhaul bill for not addressing the fate of Fannie and Freddie.  Treasury Secretary Timothy Geithner said that winding down Fannie and Freddie and creating an alternative won’t happen overnight.  “Realistically, this is going to take five to seven years,” he said.  “We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market.”

The Treasury Department report suggests that Fannie and Freddie purchase loans with smaller outstanding balances, reducing their risk.  The report also recommends phasing in a requirement that Fannie and Freddie borrowers make larger downpayments — at least 10 percent.  Lastly, the government wants Fannie and Freddie to wind down their own mortgage investment portfolios.  In their heyday, Fannie and Freddie were public companies that encouraged home ownership thanks to a Congressional mandate.  The companies buy home loans from lenders, which use the money to offer new loans to consumers.

The bad news is that mortgage costs could increase a bit once Fannie and Freddie are phased out. “Over the long run, the cost of a mortgage will rise modestly for the average American homeowner,” Geithner said.  “We think it’s very important for the government to continue to play a role, a targeted role” to make certain that “Americans who need help to find a home, to rent a home, or own a home get that help.”

Nor will the process of replacing Fannie and Freddie be easy.  Writing in the Wall Street Journal, David Reilly points out that “A return of private capital requires the revival of securitization markets for mortgages not backed by the government since bank balance sheets aren’t big enough to fill the gap”.  But 30-year loans in their current form aren’t attractive to investors without a government guarantee. The Treasury implicitly acknowledges the conflict, noting that the less government backing there is for housing finance, the less feasible the 30-year mortgage becomes.  It also admits the reward for losing that benefit, and largely removing government from mortgage markets, would be a reduced incentive to invest in housing so that ‘more capital will flow into other areas of the economy, potentially leading to more long-run economic growth and reducing the inflationary pressure on housing assets.’  That should be the clear goal of any housing-finance revamp.”

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