Financial Regulatory Forum

SCENARIOS – Reshaping Fannie Mae and Freddie Mac

By Reuters Staff
March 22, 2010

WASHINGTON, March 22 (Reuters) – Treasury Secretary Timothy Geithner is expected to lay out the Obama administration’s broad vision for restructuring mortgage finance giants Fannie Mae and Freddie Mac on Tuesday in congressional testimony.

Geithner has said that any specific legislative proposals will not come until 2011 at the earliest. His testimony before the House Financial Services Committee on Tuesday is expected to be the first step in a long journey to make changes to the existing housing finance system.

The government seized Fannie and Freddie at the height of the financial crisis, in what at the time was said to be a temporary measure to ensure credit remained available for homebuyers.

Last fall, the U.S. Government Accountability Office said that move will likely muddy efforts to restructure the two companies, which own or guarantee about half of U.S. residential mortgages.

The GAO said the two government-sponsored enterprises have a mixed record in meeting their mission to foster affordable housing, and that both capital and risk management deficiencies had compromised their safety and soundness.

The GAO analysis examined a series of options that could be considered for Fannie Mae and Freddie Mac.

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Following are some scenarios, gleaned from comments by policy makers, analysts and the GAO report, for the two mortgage lending giants.

FULL NATIONALIZATION

This might be the easiest option and would return the companies to their origins as a government tool to nurture the housing market.

Shareholders have had stakes in Fannie Mae and Freddie Mac only for about 40 years. Before that, the companies were fully owned and guaranteed by Washington.

Under the current conservatorship, Fannie Mae and Freddie Mac are effectively in government hands again. Policy makers could choose to hold that status quo and formally eliminate investors’ interest.

That said, White House economic aide Lawrence Summers has said full nationalization is not the direction he would expect the government to take.

The government could decide to have Fannie and Freddie focus on buying qualifying mortgages and issuing mortgage-backed securities, and not allow them to hold mortgage debt in their own portfolios. The Federal Housing Administration, which insures mortgages for low-income and first-time borrowers, could assume more responsibility for promoting homeownership for targeted groups.

PRIVATIZATION WITH PAYMENT FOR INSURANCE

Policy makers might return the companies to investors and offer to insure Fannie Mae and Freddie Mac investments.

Washington could charge the companies a fee to underwrite their debt and some of their mortgage securities as a way to nurture the housing finance sector without standing squarely behind the companies. This idea, aired by Federal Reserve Chairman Ben Bernanke, would be akin to the Federal Deposit Insurance Corporation’s protection of banks.

COOPERATIVES WITH LOOSE GOVERNMENT TIES

Fannie Mae and Freddie Mac could be run by the companies that sell them home loans. In such an arrangement, Fannie and Freddie would focus on long-term, stable business rather than maximizing profits. The federal government might still offer to insure the companies against the most catastrophic losses. This arrangement could be akin to the Federal Home Loan Bank system where a dozen regional lenders are jointly and severally liable for any one member’s losses and the federal government acts as guarantor of the entire system.

UTILITIES MODEL

Just like power and water companies that provide vital services, Fannie Mae and Freddie Mac could be run as private entities with strong government oversight. The companies would aim to turn a profit and would have no government backing, but a conservative board would set earnings payments and customer fees.

PRIVATE MORTGAGE-FINANCE COMPANIES

Although Fannie and Freddie are in government hands, their regulator is still trying to keep their shares trading. The two could emerge as large mortgage finance companies that bundle home loans for investors and raise funds in the traditional capital markets. Without government ties, though, the companies would not have lower funding costs and so would not enjoy the competitive advantage they do now. The federal government would also lose one of its most powerful tools for helping low-income home buyers.

GAO said privatizing or terminating Fannie Mae and Freddie Mac would disperse mortgage lending and risk management through the private sector.

COVERED BONDS

While they are currently only a talking point on Wall Street, covered bonds could become a mortgage finance tool to rival the influence of Fannie Mae and Freddie Mac. Unlike traditional mortgage-backed securities, which are frozen blocks of home loans, covered bonds allow banks to manage a dynamic pool of mortgages. Covered bonds are popular in Europe but have a weak foothold in the United States because of regulatory constraints and the competitive advantages of Fannie Mae and Freddie Mac. The fate of those companies will have a direct impact on the future of covered bonds. (Reporting by Corbett B. Daly and Nancy Waitz in Washington and Lynn Adler in New York, Editing by Chizu Nomiyama and Leslie Adler)

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