The Obama administration is sorely divided over how to reform Fannie Mae and Freddie Mac, the controversial mortgage giants. Sources familiar with the discussions raise the possibility that the White House will miss its statutory deadline for submitting recommendations to Congress.
The dispute pits White House economic advisers, who favor merely offering lawmakers a menu of possible next steps without committing to a specific direction, against officials at the Treasury and Department of Housing and Urban Development, who want to endorse an explicit federal guarantee for the mortgage companies and throw the administration's support behind it, the sources said.
The controversy is as much over strategy as substance. White House advisers aren’t certain whether going out on a limb with a specific plan will drive reforms of the federal housing finance program in a constructive way, or present an easy target for opponents. Administration officials who object to offering an explicit guarantee so early in the process say it would make it harder to negotiate a compromise. Instead, they argue, the administration would be better off laying out a range of options, to give them maximum flexibility in talks with Democratic and Republican lawmakers and industry officials.
The government currently supports 97 percent of the mortgage market, and the two entities own or guarantee nearly three quarters of that amount, or $6 trillion in debt, which policy experts and stakeholders agree can’t be indefinitely sustained.
Under the conservatorship of Fannie and Freddie, the government oversees the firms while their staff runs day-to-day operations. The debt of Fannie and Freddie isn't carried on the government's books, although the cost of the bailout will ultimately come out of taxpayer funds and impact the budget.
White House officials didn’t return calls seeking comment on the dispute, which comes as the president is revamping his economic team. President Obama this month named former Treasury official Gene Sperling director of the National Economic Council, succeeding Lawrence Summers, and picked Jason Furman as Sperling's principal deputy. Austan Goolsbee is the new chair of the White House Council of Economic Advisors, succeeding Christina Romer. And Obama recently nominated University of Maryland Professor Katharine Abraham to a seat on the council.
If the administration ends up proposing a menu of options, experts said some of the possible plans for Fannie and Freddie -- each with its pros and cons -- include:
- Eliminating the agencies and relying on the FHA to guarantee loans for low-income homebuyers, while the private sector serves middle- and upper-income families.
- A hybrid public-private model that insures mortgages and has an explicit government guarantee.
- A heavily regulated system designed like a traditional electric utility, with the government regulating fees that could be charged to consumers.
- A cooperative model similar to the Federal Home Loan Bank system, in which member banks are shareholders in the overall institution.
Treasury faces a Jan. 31 deadline under the Dodd-Frank financial overhaul legislation to issue a report and make recommendations on the future of Fannie and Freddie, which the government took control of in September 2008 to avoid a complete financial meltdown in the event the two government-sponsored enterprises collapsed.
"There's good recognition that the current situation is not sustainable in the long term and there's a need for fundamental reform," said Michael S. Barr, a law professor at the University of Michigan who was a Treasury official before leaving late last year. "It's going to be a challenging political environment in the next couple of years, particularly with the changes that happened in the House."
Treasury Secretary Tim Geithner has said reform of Fannie and Freddie is his top legislative priority, one of several for which the administration is feeling pressure from Congress to demonstrate progress, given the estimated $400 billion price of propping up the institutions.
"We are working now to prepare a proposal for the future of Fannie Mae and Freddie Mac and that's what we're focused on," said Treasury spokesman Steven Adamske, adding that the administration plans to meet the Jan. 31 deadline, but "nothing is set in stone."
Spokespeople for HUD, Fannie, Freddie and the Federal Housing Finance Agency declined to comment on the internal administration dispute.
Last year's financial regulatory overhaul failed to address Fannie and Freddie, leaving the firms' future the last big piece of the financial crisis still awaiting congressional action. The challenge for policymakers is to attract private investors back into the mortgage market while retaining the benefits that Fannie Mae and Freddie Mac established -- a liquid secondary mortgage market and greater access to homeownership. They 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.
The stakes are high: the stability of the mortgage market, economic growth and, some argue, the future of the 30-year fixed-rate mortgage. "If we do this right, we will have a system that will preserve the macro-economy in the next crisis -- which could be a severe global one -- and allow options for American families," said Susan Wachter, a professor at the Wharton School at the University of Pennsylvania.
Divided Interests in Congress
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 lawmakers' concern about ongoing practices related to foreclosure.
Interested parties -- from the real estate and mortgage industry to affordable housing advocates -- have proposed several ways to replace Fannie and Freddie. Those range from a private system with only the Federal Housing Administration guaranteeing loans, to a heavily regulated system similar to the pre-crisis setup, with an explicit mandate to infuse capital to underserved communities. A key question is whether the government will continue to guarantee against mortgage defaults, or limit the range of that guarantee.
While the administration is struggling to find a consensus approach, Republicans also face divided ranks. Many House Republicans are eager to dismantle Freddie and Fannie, but others are under pressure from their allies in the financial services industry and real estate sector, which want a continued government subsidy. Moreover, Senate Democrats are unlikely to move quickly unless they're confident that any legislation would protect affordable housing and the 30-year fixed-rate mortgage.
"It's clear to me there's not consensus within the Republican caucus. What's not clear is whether they can keep everyone on board," said Mark Calabria, director of financial regulation studies at the Cato Institute. "Industry-friendly Republicans might side with Democrats and end up with a guarantee. Then Republican leadership might not bring it to the floor."
With the presidential election next year, both parties will use the fate of Fannie and Freddie as a political rallying point, Calabria predicted. The Republicans will hold up the institutions as models of big-government excesses, while the Democrats will position themselves as defenders of the 30-year mortgage and affordable housing.
Rather than a huge piece of legislation restructuring the mortgage market, look for a series of smaller bills that call attention to key issues, he said. For instance, it would be politically difficult to oppose legislation that would lower loan limits to, say, $700,000. House Republicans could chip away at the size of Fannie and Freddie by passing measures to reduce their portfolios, raise capital requirements or end guarantees on new mortgages.
Since being chartered by Congress as government-sponsored enterprises decades ago, Fannie Mae and Freddie Mac drove the development of the secondary market for mortgages by purchasing loans from banks, pooling them and selling securities based on the assets. They operated as private companies that returned profits to shareholders and management, while enjoying an implicit government safety net. Investors correctly assumed the government would never let them collapse. When private investors fled the housing market in 2008, Fannie, Freddie and other government-backed programs became the only game in town. The open question is what will replace this mammoth system and how to bring back private capital.
As lawmakers and government officials debate possible changes, the administration can make some progress without legislation by reducing the role of Fannie and Freddie and encouraging more private investors in the mortgage market, said Barr, of the University of Michigan.
"We need to have an explicitly priced and paid for government backstop … and to make sure the system of the future provides access to credit for people who are ready for homeownership," said Sarah Rosen Wartell, executive vice president at the Center for American Progress. "Over time we need to have a gradual step process by which the GSEs market share falls and the jumbo market begins to be taken over by the private sector."
"Hopefully the administration's plan will be clear about what's the role of the government and what's the role of the private sector," said Phillip Swagel, a professor in the school of public policy at the University of Maryland. Regardless of what's proposed, any new model would require a lengthy transition period in which private capital would return to the market.
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Fannie and Freddie’s $37 Billion Question (The Street)