What's next for housing finance, Fannie and Freddie?

McClatchy NewspapersJuly 27, 2010 

WASHINGTON — With the overhaul of financial regulation in the bag, the Obama administration Tuesday said it'll focus next on housing finance — another key cause of the recent deep economic downturn — with an eye to deciding the fate of mortgage finance titans Fannie Mae and Freddie Mac.

The administration said in a statement that it would hold a Conference on the Future of Housing Finance at the Treasury Department on Aug. 17. It'll seek input for legislation to reform the rules governing mortgage finance and the markets for bonds backed by U.S. mortgages.

The Bush administration placed Fannie Mae and Freddie Mac in government conservatorship in September 2008. Uncertainty about what to do with them was ostensibly the reason why most Republicans voted against the recent overhaul of financial regulations.

The White House pledged Tuesday to send Congress legislation in January to revamp housing finance.

"The future of our housing finance system is critical not only to our economic recovery, but also to millions of American homeowners in every corner of our country," said Treasury Secretary Timothy Geithner in the statement. "The Obama administration is committed to delivering a comprehensive reform proposal that protects taxpayers, institutes tough oversight, restores the long-term health of our housing market, and strengthens our nation's economic recovery."

The announcement didn't quiet critics.

"Better later than never," said Alex J. Pollock, a scholar at the American Enterprise Institute, a conservative research group. "It is still my opinion that you cannot write a 2,300 page bill and not address Fannie and Freddie on the somewhat dubious excuse that it is too complicated."

President Barack Obama has said he'd tackle Fannie and Freddie, which are both chartered by Congress, separately from Wall Street, reluctant to make significant changes while the housing market remains weak and continues to slow the economic recovery. Existing home sales fell 5.1 percent in June and are expected to decline again this month. Most economic analysts now expect the housing market to bottom in 2011, five years after the crisis began.

Fannie Mae was created in 1938 to boost home ownership after the Great Depression, while Freddie Mac was created in 1970 to provide more competition to Fannie Mae. The two congressionally chartered private entities traditionally buy mortgages originated by lenders and pool them into bonds backed by U.S. mortgages. This frees banks and other mortgage lenders from having to retain the loans on their books, and allows them to keep lending to homebuyers.

Together, Fannie and Freddie guarantee about 31 million U.S. mortgages, collectively representing roughly $5 trillion in mortgage debt.

Early in this decade, Wall Street banks aggressively pushed their own secondary market for mortgage bonds, called private-label mortgage-backed securities. These banks captured significant market share from Fannie and Freddie, in part because lending standards eroded significantly and Wall Street entities had looser controls and fewer demands on mortgage originators than did the quasi-government entities.

Together the Wall Street banks, Fannie and Freddie supported a massive and ultimately unsustainable expansion in homeownership during the first half of the past decade. When the national housing market began to implode in 2006, reverberations shook housing finance to its core and led the government to seize Fannie and Freddie.

Big players in mortgage bonds on Wall Street, namely investment banks Bear Stearns and Lehman Brothers, collapsed in 2008. Investors in Fannie and Freddie mortgage bonds, once thought as safe as Treasury bonds, began clamoring for an explicit government guarantee. These financial instruments were always thought to be implicitly backed by the U.S. government.

Absent an explicit guarantee, investors began to shun this vital secondary market, which is needed for U.S. housing finance to function. Then-Treasury Secretary Henry Paulson concluded that if investors were to get such a guarantee, then Fannie and Freddie should be in government hands.

"Our economy and our markets will not recover until the bulk of this housing correction is behind us," Paulson said on Sept. 7, 2008, announcing the historic government takeover. "Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance" for ordinary Americans.

At the time, Paulson said Fannie and Freddie would buy up even more mortgages in 2009, and then begin to shrink their portfolio of mortgage bonds by 10 percent a year beginning in 2010. However, the housing downturn has been so severe and the crisis in credit markets so deep that the private sector's secondary market remains shut. That's left Fannie and Freddie the only game in town — the only place for mortgage originators to unload their loans in order to keep lending to homeowners.

"Continuing to provide financial support to Fannie Mae and Freddie Mac was the right decision then for the mortgage market and for our economic recovery — and it has played a critical role in stabilizing the housing industry during a period of crisis," said Jeffrey Goldstein, Treasury undersecretary for domestic finance, in a White House blog Tuesday. "Even today, private capital has not yet fully returned to this market. Fannie Mae, Freddie Mac and other government entities guarantee more than 90 percent of newly originated mortgages. They are practically the only game in town."

Critics of Fannie and Freddie want the government eventually out of the mortgage finance business.

"At the end of this thing, there needs to be a private conforming mortgage market. It's never existed," Pollock said. He said that conventional mortgages given to safe borrowers should be pooled together by private firms. Fannie and Freddie's advantage as quasi-government entities allowed them to bundle the safest loans that represented the brunt of the mortgage market.

Appearing Sunday morning on NBC, Geithner envisioned some government role at the end of the housing-finance overhaul process.

"I think we're not going to preserve Fannie and Freddie in anything like their current form. We're going to have to bring fundamental change to that market. But I think there's going to be a good case for taking a look at a preserving or putting in place a carefully designed guarantee so, again, homeowners have the ability to borrow to finance a home even in a very difficult recession," he said.

WHO THEY ARE

Federal National Mortgage Association, or Fannie Mae: Created in 1938 during the Great Depression era to promote home ownership through purchases of mortgages insured by the Federal Housing Administration. In 1968, it was taken off the federal budget and made into a congressionally chartered private corporation owned by shareholders. In 1970, it was authorized to buy private mortgages.

Federal Home Loan Mortgage Corporation, or Freddie Mac: Created by Congress in 1970 to compete with Fannie Mae and foster a more robust secondary market.

HOW THEY OPERATE

Fannie and Freddie purchase mortgages from banks and other mortgage lenders, pooling those home loans for sale in a secondary mortgage market as a special bond, called a mortgage-backed security. This secondary market for loans means lenders don't have to hold a loan on their books, freeing them up to do more lending to home buyers.

THEIR IMPACT

Together, Fannie and Freddie today guarantee about 31 million U.S. mortgages. Those mortgages represent a combined $5 trillion in mortgage debt. With the private sector impaired, Fannie and Freddie currently repurchase roughly 9 out of every 10 new mortgages.

ON THE WEB

Pollock on fixing housing finance

White House blog

Geithner on Meet the Press

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