U.S. Treasury Secretary Timothy F. Geithner presented Congress with a set of options for weaning the $11 trillion mortgage market from its dependence on the government, while calling for changes to be phased in “responsibly and carefully” to avoid economic disruptions.
The report delivered today by Geithner and Housing and Urban Development Secretary Shaun Donovan presents three approaches for a future housing finance system. It calls for the government to shrink “and ultimately wind down” Fannie Mae and Freddie Mac, the bailed-out government-sponsored enterprises that helped fuel the housing bubble before being felled by investments in subprime mortgages.
The transition to a new housing-finance system will likely take five to seven years, Geithner said during a conference call with reporters.
“I want to emphasize we’re going to proceed on this path to reform very carefully, so we make sure we’re supporting the process of economic expansion and repair of the housing markets, which of course are still suffering from the damage caused by the crisis,” he said.
The plan doesn’t endorse a particular long-term option or offer legislation. All three proposals would accompany an end of taxpayer support for Fannie Mae and Freddie Mac, which together have drawn more than $150 billion from the Treasury since they were seized by the government in September 2008.
In Congress, the report’s release is the opening bell for a political and policy bout over how to fix the mortgage-finance system, a debate that is likely to last months or years. Real estate brokers and developers have told lawmakers that the housing market dominated by Fannie Mae and Freddie Mac remains too fragile to survive a precipitous overhaul.
With the decline of private investment in home loans since the credit crisis, the two companies, along with the Federal Housing Administration, have come to own or insure almost 97 percent of mortgage bonds.
Geithner, who said the government took its support for housing “too far” heading into the credit crisis, said the administration of President Barack Obama can take initial steps without legislation and then will need lawmakers to step in.
“We don’t want legislation to be too far deferred,” he said at a conference in Washington today. “Ultimately we’re going to have to explain to the market what the end game’s going to be and we can’t wait too long.”
Geithner said the federal government will continue to back Fannie Mae and Freddie Mac during the transition.
“We’re going to make it very clear to the market and to investors we will make sure Fannie and Freddie have the resources they need to meet all their commitments as they go through the process of reform,” he said on the call with reporters.
Though the administration envisions a smaller federal role in the mortgage market, the Federal Housing Administration should continue to support affordable housing, Donovan told reporters.
“FHA is a critical part of ensuring access and affordability for low-income Americans and we must continue that,” Donovan said.
The three options presented by Treasury suggest differing degrees of government involvement in the system. The most dramatic would largely privatize housing finance, leaving a government role to help “narrowly targeted” low-income buyers, rural residents and military veterans.
The approach would “drastically reduce” taxpayer exposure to failed loans, the report said, while adding “particularly acute costs” to credit for many borrowers. The plan would boost interest rates and could make the traditional 30-year, fixed-rate mortgage hard to get, according to the report.
A middle ground would replace Fannie Mae and Freddie Mac with a system that helps low-income, rural and veteran buyers in normal times and also provides an expanded guarantee that the government could ramp up in a crisis. The paper suggests using high-priced fees or restricted amounts of public insurance to achieve this goal.
“Private actors would be on the hook for their own risky decisions and the government would not be putting taxpayers at direct risk in backing the nation’s mortgage market,” the report said. Designing a guarantee system that could grow and shrink would be a “significant operational challenge,” the report concluded.
A third option, which has drawn the most attention and interest from consumer and industry groups, would have the biggest government role and would hew closest to the current system. It would impose more regulation and give the government a role in “catastrophic reinsurance behind significant private capital” to provide a backstop in times of crisis.
Under this system, private companies could insure mortgage bonds with the government paying out only to shareholders who “have been entirely wiped out,” according to the report.
The approach would provide the “lowest-cost access to mortgage credit,” the report said, by attracting a large pool of investors, thus boosting liquidity. The option carries risks. If the system attracts too much capital, it could “artificially inflate the value of housing assets,” much like what happened in the years leading up to 2008.
It also doesn’t necessarily protect taxpayers, the report said. If oversight is lax or government premiums are underpriced, “private actors in the market may take on excessive risk and the taxpayer again could bear the cost,” the report said.
All options threaten to make mainstream credit less available, pushing low- and moderate-income borrowers into FHA loans, said Debby Goldberg, a project director at the National Fair Housing Alliance. “It’s possible that the third option might provide the best protection against concentration in the market but it lacks the details to assure us that that’s the case.”
Fannie Mae and Freddie Mac mortgage securities were little changed after the plan’s release. Fannie Mae’s current-coupon 30-year fixed-rate bonds yielded 0.78 percentage point more than 10-year Treasuries as of 2:30 p.m. in New York, compared with 0.79 percentage point yesterday, according to data compiled by Bloomberg.
Spreads on Fannie Mae’s five-year unsecured debt fell 0.02 percentage point to 0.11 percentage point, down from 0.19 percent point on Feb. 3, as the proposal suggested shrinking the balance sheets of the companies and Federal Home Loan Bank system over time, reducing the supply of their borrowing.
The Treasury proposal also recommends several steps that can be taken quickly to begin easing government out of the market.
One is to increase the monthly insurance premiums, or guarantee fees, now charged by Fannie Mae and Freddie Mac. Higher premiums would in theory give other companies incentive to compete for lending.
The fees, which are negotiated lender by lender and vary depending on a loan’s size and quality, averaged 0.22 percent for GSE-insured mortgages in 2009, down from 0.25 percent a year earlier, according to the Federal Housing Finance Administration, which regulates Fannie Mae and Freddie Mac.
The administration plan also recommends increasing Federal Housing Administration premiums by 0.25 percentage points. The plan suggests lowering the ceiling for loans that Fannie Mae and Freddie Mac can insure. The cap on those conforming loans is scheduled to drop from $729,750 to $625,500 on Oct. 1 if Congress doesn’t act. Larger nonconforming, or jumbo, loans typically carry higher interest rates.
The administration endorsed an existing law that forces the GSEs to shed loans in their almost $1.5 trillion portfolios by at least 10 percent a year as a way to reduce government exposure to failing mortgages.
The outcome could be a question of survival for many in the real estate industry, including millions of brokers and builders whose livelihoods depend on an abundance of inexpensive loans.
They are generally aligned with housing and consumer advocates who say a government withdrawal that goes too far would put homeownership out of reach for many borrowers and give too much power to financial companies.
‘Sensitivity and Oversight’
“Greed is not going to disappear,” said John Taylor, president and chief executive officer of the National Community Reinvestment Coalition, a Washington-based group that promotes access to banking and credit services for underserved communities. “What will disappear is the sensitivity and oversight not to engage in bad practices.”
Congress established Washington-based Fannie Mae in 1938 and Freddie Mac of McLean, Virginia, in 1970 to increase the capital available for home lending by packaging mortgages into bonds for sale to investors. The companies insured bond buyers against losses, with an implied promise that the U.S. government would make investors whole if the system failed.
In an Oct. 20 interview with the Financial Crisis Inquiry Commission, made public when the panel released audio tapes yesterday, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said Fannie Mae and Freddie Mac were “the biggest disasters of all time” and a leading cause of the U.S. financial crisis.
Freddie Mac Chief Executive Officer Charles E. Haldeman Jr. today congratulated the administration on its report.
“Clearly they understand the key issues and the need for private-sector capital to return to the housing market,” Haldeman said in a written statement.