U.S. Treasury officials are leaning toward recommending that Fannie Mae and Freddie Mac be replaced with a government safety net for the mortgage finance system and continued federal backing for loans to lower-income homebuyers, according to three people briefed on the discussions.
Treasury Secretary Timothy F. Geithner has said in recent public appearances that an agency recommendation for winding down the two taxpayer-owned mortgage companies could be released in coming weeks. It hasn’t yet been determined whether the plan, likely to be a broad outline rather than a detailed prescription for legislation, will be released that soon, the people said.
In timing its proposal, Treasury must balance political and economic realities. Presidential campaign politics and deep divisions between Democrats and Republicans in Congress make it unlikely that mortgage-finance reform will be enacted this year. At the same time, the lack of a clear blueprint is contributing to continued weakness in the housing market, said Karen Dynan, a former economist with the Federal Reserve Board of Governors.
“The uncertainty surrounding the future of the mortgage finance system has impeded the rebound of the housing market and the private housing-finance market,” said Dynan, who now serves as a vice president at the Brookings Institution. “It’s just really hard for the players to make decisions when you don’t know what the rules are going to be in the future.”
The two companies, which veered toward bankruptcy when the housing market collapsed in 2008, were seized by regulators and have drawn almost $190 billion in taxpayer aid. Fannie Mae and Freddie Mac became targets of at least 18 Republican bills seeking to reduce or eliminate the government role in mortgages.
Dominating the Market
The debate over the companies’ future has been complicated by their growing prominence in the housing market. As private investors have pulled back in the recession, Fannie Mae and Freddie Mac have come to own or guarantee 60 percent of outstanding U.S. residential mortgages. That has prompted the real estate industry to lobby Congress to move slowly on reducing the government’s role.
“There’s a lot of ideological chest-pounding about getting the government out of housing, but I think most people recognize that if it’s done in any precipitous fashion, it will have negative consequences for the American homeowner, consumer and economy,” said Jim Millstein, Treasury’s former chief restructuring officer, who is now chairman and chief executive officer of Washington financial advisory firm Millstein & Co.
Mitt Romney, the leading contender for the Republican presidential nomination, has criticized Fannie Mae and Freddie Mac and has called for more private capital in the mortgage market, but has not released specific plans.
While some Republicans who initially called for immediate abolition of Fannie Mae and Freddie Mac now say they would accept a gradual wind-down, split party control of Congress stands in the way of resolving the matter in 2012.
“The political environment is dysfunctional,” Michael Barr, a University of Michigan law professor and former assistant Treasury secretary for financial institutions, said in an interview. “The presidential campaign is taking up all the oxygen. There’s almost no appetite for compromise on anything substantive.”
Geithner more than a year ago unveiled three options for weaning the mortgage market from its government dependence. He said in February that he expected to “lay out more detail” about the approach “in the spring.”
While a Treasury official said all options remain under review, the people familiar with the talks said the third option -- the one with the largest government role -- most closely resembles what the Obama administration is likely to propose.
Under that system, the government would supply “assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private capital,” according to the Treasury report released in February 2011. Private companies could insure mortgage bonds, with the government paying out to bondholders only after shareholders were “entirely wiped out.”
In formulating their plan, Treasury staff members are also examining bipartisan legislation introduced in Congress, said the people, who spoke on condition of anonymity because the discussions are private. One bill, co-sponsored by California Republican Gary Miller and New York Democrat Carolyn McCarthy, would create a government-run “secondary market facility” for residential mortgages to replace Fannie Mae and Freddie Mac.
A second measure drawing Treasury interest was introduced by John Campbell, a California Republican, and Gary Peters, a Michigan Democrat. It would replace the government-sponsored enterprises with privately-capitalized entities that would purchase government backing for the mortgage bonds they issued.
Geithner has stressed that any Treasury plan will aim to shrink the government footprint in housing finance.
“Our plan will wind down the GSEs and bring private capital back into the market, reducing the government’s direct role in the housing market and better targeting our support towards first-time homebuyers and low- and moderate-income Americans,” he said during a Feb. 2 press conference.
Treasury officials also are focused on the government’s role in making mortgages affordable for lower-income borrowers, the people said. Michael A. Stegman, who joined Treasury this year as a counselor on housing finance policy, once headed a research project on affordable homeownership at the University of North Carolina that made the case that loans to low-income borrowers performed well as long as the terms were similar to those given to borrowers qualifying for prime rates.
“We’ve got fairly good evidence here that carefully structured financing for lower-income households to buy a home can be very successful,” said Janneke Ratcliffe, who now directs the Center for Community Capital, which Stegman founded.
Meanwhile, the Federal Housing Finance Agency, the regulator of Fannie Mae and Freddie Mac, is proceeding with its own plans for shrinking their footprint.
In a strategic plan released in February, FHFA director Edward J. DeMarco said the enterprises should begin entering into arrangements that would allow them to share the risk on some of their portfolio with private capital, expanding reliance on mortgage insurance, and raising the fees they charge to guarantee mortgage-backed securities.
Fannie Mae said in a recent financial disclosure that part of its executives’ pay was dependent on how well they managed to “contract the Enterprises’ dominant presence in the marketplace while simplifying and shrinking certain operations.”
Opinion among housing experts is mixed on whether it makes sense for the Treasury to release a plan before the election.
Filling a Vacuum
“At this point in time, I don’t see the value, political or otherwise, in Treasury announcing their own discrete plan for GSE reform unless it’s done in close collaboration with FHFA,” said Tim Rood, managing director of the Collingwood Group, a Washington-based consulting firm. “FHFA appears to be filling the housing policy vacuum and has recently published a very cogent and thoughtful strategic plan for the GSEs.”
In Dynan’s view, it makes sense to move forward as quickly as possible. Uncertainty over the future role of the government in housing finance may be impeding the market for private-label mortgage-backed securities because investors and issuers don’t know what the rules and regulations will be, Dynan said. Also, she said, lenders aren’t able to develop long-term policies.
“The sooner we can come up with a plan to either reform or replace these entities, the better it is for restoring the health of the housing market,” she said.
To contact the reporters on this story: Clea Benson in Washington at firstname.lastname@example.org; Ian Katz in Washington at email@example.com; Cheyenne Hopkins in Washington at firstname.lastname@example.org