This story was updated at 3:50 PM on Friday, February 11.
The Obama administration Friday laid out an ambitious vision for U.S. housing finance reform, in which the government gradually diminishes its role and private investors return to the mortgage securities market.
But the plan doesn't specify how to overhaul or eliminate Fannie Mae and Freddie Mac, instead setting out three possible options for the mortgage giants, which have been operating under government conservatorship since September 2008. Under the landmark Dodd-Frank financial overhaul legislation approved last year, the Treasury Department was supposed to present to Congress by Jan. 31 a report on the government-sponsored enterprises (GSEs) to help lawmakers write legislation to reform the agencies.
"This is a plan for fundamental reform — to wind down the GSEs, strengthen consumer protection, and preserve access to affordable housing for people who need it," said Treasury Secretary Timothy Geithner in a statement. "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."
At stake are the health of the real estate market, economic growth and, some argue, the future of the 30-year fixed-rate mortgage. The challenge for policymakers is to attract private investors back into the mortgage market while retaining the benefits that Fannie and Freddie established — a liquid secondary mortgage market and greater access to homeownership. The administration and lawmakers are also attempting to prevent a repeat of the excessive risk-taking and inadequate supervision of the housing market that led to the 2008 financial crisis, while reassuring foreign investors in housing bonds and U.S. government debt.
"The government is committed to ensuring that Fannie Mae and Freddie Mac have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations," the plan said, recommending that the firms reduce their portfolios by at least 10 percent each year as they wind down.
Through Freddie, Fannie, Ginnie Mae and federal housing programs, the government currently supports 97 percent of mortgage securities issued each year. The two entities own or guarantee nearly three quarters of existing U.S. mortgages, or $6 trillion in debt, which policy experts and stakeholders agree can’t be indefinitely sustained. Together, they've cost the government $150 billion since the takeover.
The Treasury report recommended ending the advantage that Fannie and Freddie enjoy in the mortgage market by requiring them, over several years, to raise the fees they charge for guaranteeing mortgages to the same level that they would charge if they met capital standards applied to private banks. The report called for Congress to lower the limits on the size of home mortgages that Fannie and Freddie guarantee and recommended gradually increasing required down payments to 10 percent of the loan. There's currently no hard-and-fast minimum down payment, but 3 percent isn't uncommon for newly guaranteed Fannie and Freddie mortgages.
Under the plan, the Federal Housing Administration would return to its traditional role of supporting low-income homeowners, also through a combination of lower loan limits and higher fees and new support for rental housing. It calls for a new task force to ensure that federal agencies work together and with Congress to craft a smooth transition plan to a private sector-supported mortgage market, as well as developing a dedicated funding source for affordable housing. The Treasury emphasized its commitment to ongoing reforms in the mortgage industry to protect consumers and increased disclosure by loan originators and securitizers, as well as stronger capital standards and government oversight of risks to the entire financial system.
The three long-term options described by the white paper are to:
- Limit government involvement to FHA programs aimed at low-income homeowners.
- Complement FHA with a emergency federal backstop that would only be used in times of crisis.
- Establish, alongside FHA, some kind of standing government-backed insurance that would be available for broader class of middle-income homeowners, but would be more limited than the current system.
"It would be fundamentally untenable for the country to adopt a model where the government plays no role and we also think it would not make sense for the government to be in a position, on an ongoing basis, of guaranteeing 80 to 90 percent of the mortgage market," Geithner said at a Brookings Institution event Friday.
He acknowledged the serious mistakes by the government and failure of the current system, but said it will take time to transition to a better structure. He set out a time frame of two years for Congress to pass reform legislation and another five to seven years to implement the new model.
"It's absolutely the case that the U.S. government provided too much support for housing, too strong incentives for investment in housing and we just took that too far," he said. "We need to proceed carefully and gradually not just because this is very complicated, but as you know we're still living with the traumatic damage and scars caused by this recession and you see those still in housing most powerfully."
The administration faces a hostile environment in Congress, with the new Republican-controlled House gearing up to oppose a continuing large government role in housing finance — through piecemeal legislation if need be. The mortgage giants have a controversial track record, from Freddie Mac's 2007 settlement of accounting fraud charges and criticism of high executive pay to ongoing practices related to foreclosure.
Administration aides had argued that offering a range of options would be a better strategy for the Treasury to win true reform through negotiation, rather than presenting a single plan for Fannie and Freddie that would draw criticism from all sides. Democrats are split on how to continue to meet affordable housing goals, how heavily regulated a new model should be and how big a role the government should play in guaranteeing mortgage debt versus simply providing insurance on the debt, perhaps for a fee.
Republicans are also split on the future of the agencies, with their traditional small government stance coming into conflict with their allies in the housing and financial services industry, who want a continued government subsidy. With the presidential election approaching, a real danger is that the future of Fannie and Freddie will become a political football without any real legislative action.
"We are committed to our immense responsibilities," Michael Williams, president and CEO of Fannie Mae said in a statement. "We are focused on doing our job well — funding the market, building a sound new book of business, cutting losses in our legacy book, helping distressed borrowers, stabilizing neighborhoods, and driving operational excellence. We will continue to draw from our reservoir of deep knowledge and experience to offer helpful input and pose important questions."
Former Federal Reserve Board Chairman Alan Greenspan told the Brookings audience that with the government supporting virtually all of the mortgage market, it's impossible to know how much private investment could come in to replace Fannie and Freddie and at what interest rates. He recommended that policy makers develop a financial model to understand the situation before moving forward with regulatory and legal changes.
"We're starting somewhere in the middle, working our way backwards and forwards," with the Treasury plan, said Greenspan, a long-time critic of Fannie and Freddie. "I've been looking at this market for generations and I don’t have a clue what we have here. ... An amortized 30-year mortgage has a value to investors. The only question is at what yield."
The housing market had such a long stretch of growth, and then a dramatic drop, that it would take another 10 percent increase in prices for the market to return to normal, he said.
Housing policy experts stressed the importance of firming up a plan for Freddie and Fannie before the urgency of the moment passes.
"I worry we're a long way from committing to a plan," said Karen Dynan, senior fellow and co-director of Brookings' Economic Studies program. "We have this uncertainty hanging over the markets."
The third option in Treasury's white paper seems the most plausible direction, according to Brookings senior fellow Ted Gayer, who is Dynan's co-director, as well as Sarah Rosen Wartell, executive vice president at the
Center for American Progress. The analysis of affordable housing is helpful but thin, as is the treatment of rental options, Wartell said.
"It's extremely well-written," she said of the white paper, which lays out the pros and cons of each of the options. "I find their own reasoning to be convincing that the first two options are not viable options."
Robert C. Pozen, a senior lecturer at Harvard Business School, urged policy makers to give sincere consideration to options 1 and 2, given that the mortgage markets are already undergoing reforms and may not need an ongoing subsidy. "This industry wants to be supported, like any industry," Pozen told the Brookings audience. "It has to have a policy basis ... It seems crazy if we're going to wind up essentially justifying a government guarantee on the grounds that we can't accept prepayment fees in the first five years of a 15- or 30-year mortgage."