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Monday, April 4, 2011

The Obama Administration’s Report on “Reforming America’s Housing Finance Market”: Implications for Fannie Mae and Freddie Mac

Mark Jickling
Specialist in Financial Economics

In February 2011, the Obama Administration released a report, “Reforming America’s Housing Finance Market,” setting out several options for the future of housing finance. In the past, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have played a crucial role in government support for the mortgage market. In 2008, however, both firms were taken over by the government and have received government life support since then. Fannie and Freddie continue to provide funds for mortgage lending, at a time when private capital has largely exited the market and not yet returned, but the expense to the government has been high: through the end of 2010, the Treasury has contributed $90.2 billion to Fannie and $63.7 billion to Freddie.

The Administration’s report argues that Fannie and Freddie’s failures expose basic flaws in the GSE model. Poor regulation, excessive risk-taking, and an implicit government guarantee of Fannie and Freddie debt contributed to a situation in which GSE profits went to private management and shareholders, but losses fell to the taxpayers. The Administration proposes to shrink Fannie and Freddie’s role in housing markets as private capital returns. No specific timetable is set out in the report, but Treasury Secretary Timothy Geithner has estimated that the process of winding down Fannie and Freddie may take five to seven years.

The Administration proposes to raise the fees Fannie and Freddie charge for guaranteeing mortgage debt, limit the types of mortgages they can buy, and reduce the size of their investment portfolios. These steps can occur without congressional action—the effect would be to remove the GSEs’ competitive advantages and allow private firms to compete on a more equal footing.

For the long-term, the report sets out three options: (1) a private system of housing finance, with government intervention only to support homeownership among specific groups, such as veterans or low-income families; (2) a private system with a federal backstop that would only operate in a crisis; and (3) a system of regulated private mortgage insurers backed by a federal reinsurance system, with premiums set high enough that taxpayers would bear losses only after significant amounts of private capital had been wiped out. In general, option 1 implies less risk for taxpayers, but more expensive or less available mortgage credit. Option 3 would provide the most support to the broad mortgage market, but would expose taxpayers to more risk and also have more potential to distort market incentives and private investment decisions.

Other proposals would lie on either end of the continuum represented by the Administration’s three options. H.R. 1182 (Representative Hensarling) seeks to stem taxpayer losses by setting a two-year limit for the conservatorships of Fannie Mae and Freddie Mac and providing conditions for the continued operation of the firms or for the dissolution of the GSEs if they are judged to be not financially viable.

Proposals from the Mortgage Bankers Association and the Center for American Progress envision a more active federal role in the housing market, with new government-chartered entities taking on some of Fannie and Freddie’s functions, but with additional regulation and safeguards. In short, in reforming the GSEs, Congress faces a trade-off between placing the taxpayer at risk to downturns in the mortgage market and reducing that risk, which could make mortgage credit less available and affordable to American households.

For a broader discussion of GSE reform, see CRS Report R40800, GSEs and the Government’s Role in Housing Finance: Issues for the 112
th Congress, by N. Eric Weiss.

Date of Report: March 24, 2011
Number of Pages: 11
Order Number: R41719
Price: $29.95

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