Treasury eyes plan for smaller-scale Fannie, Freddie

Treasury puts forth menu of options, calls for hikes in guarantee fees

WASHINGTON (MarketWatch) — A large portion of Fannie Mae and Freddie Mac should be wound down over time while the fees that the troubled mortgage refinance giants charge for guaranteeing mortgages sold to investors are increased to slowly ease the private sector back into the housing market, the Treasury Department said Friday.

The long-awaited report on the future of companies, key cogs in the nation’s housing-finance system, included both these more immediate moves as well as three options for reforming the two mega-firms.

The options preserve the ability of the Obama administration to have a behind-the-scenes dialog with congressional Republicans over the future of the nation’s still-fragile housing-finance system.

One long-term approach, backed by key GOP lawmakers, would create a virtually privatized system significantly reducing the government’s role in the mortgage market by only allowing the Federal Housing Administration and two other agencies to guarantee some mortgages for low- and moderate-income borrowers that meet creditworthiness criteria.

Another long-term approach would create a similar targeted guarantee program but also set up a catastrophic-risk insurance fund that could be put into effect in the event of massive crises.

The third would set up a similar guarantee approach, but the government would also offer reinsurance for securities of a targeted range of mortgages.

These long-term solutions would require major legislative changes — something that take years to realize — as lawmakers contemplate the their impact on a housing market that’s expected to yield another record year of foreclosures.

The Dodd-Frank act set a Jan. 31 deadline for the Treasury to release the report, which the agency missed by a couple weeks.

Changed landscape

Fannie (FNMA)  and Freddie (FMCC)  have long been crucial to the housing market, guaranteeing or owning roughly 50% of the residential mortgage market. Including Federal Housing Administration loans, the government has been responsible for about 95% of mortgage origination between 2008 and 2010, according to a Bank of America Corp. analysis.

However, in the short term, the Treasury’s seeking to have Fannie and Freddie increase the price they charge for guarantees to private-market levels. In its report, the Treasury said the goal would be to help “level the playing field” and drive investors to once again buy private-label residential mortgage-backed securities.

The Treasury also recommended that Congress should not pass new legislation continuing a provision that allows Fannie and Freddie to buy mortgages with values as high as $729,750, the level to which it was raised in 2008. Without action by Congress, the limit on loans that Fannie and Freddie can buy will drop back to a maximum of $625,500 effective Sept. 30.

Republicans support going to the lower limit, which would make it more expensive for some higher-end borrowers to obtain access to credit at the same time as it limits potential costs to taxpayers.

The Treasury’s report also recommends a gradual increase in down payments required for Fannie and Freddie to guarantee a mortgage to as high as 10% over time.

The two mortgage giants were originally set up by Congress to expand home-ownership by having Fannie and Freddie buy up mortgages from banks and other direct lenders so they would have the capital to lend more. They package them into bonds and mortgage-backed securities, some of which they keep in their portfolio and others that they sell to investors.

Fannie and Freddie charge investors a “guarantee fee” in return for backing the mortgage bonds they sell. However, the two companies became saddled with toxic mortgages and were nationalized at the peak of the financial crisis in 2008 to avoid losses and stem the credit contagion.

As of October, Fannie and Freddie have cost taxpayers roughly $151 billion in taxpayer funds, used to cover their losses, with more losses expected on the horizon.

Both Republicans and Democrats have been hesitant to move forward with legislation to reform the housing companies because of the impact any changes — or even the announcement of changes — could have on the economy recovery and the housing market.

Republicans at odds with Geithner

With the GOP back in control of the House of Representatives, lawmakers have begun to hold hearings on the subject but have yet to introduce legislation. Republicans have expressed support for some recommendations in the report, but not others.

For example, regarding the $729,750 cap, no Democratic effort to reinstate the higher purchase limit would pass because Republicans in House are not going to support such an extension, said Jaret Seiberg, analyst at MF Global Inc.

Bank of America analyst Ralph Axel contends that mortgage rates could increase — particularly for larger mortgages — if guarantee fees are hiked and the size of loans that Fannie and Freddie can buy drop to lower levels. These so-called high credit borrowers “will experience continued access to financing and get the jumbo mortgages at the higher rate, but there will be a segment of population that is borderline and once the loan limits decline, there will be some people unable to get financing,” he said.

Rep. Jeb Hensarling (R., Texas) and other Republicans want to take further steps limiting what mortgages Fannie and Freddie can buy.

Hensarling is expected shortly to again introduce a bill, “The GSE Bailout Elimination and Taxpayer Protection Act.” which would eventually wind down both Fannie and Freddie. It includes a provision that would, during the winding-down transition period, only allow Fannie and Freddie to make mortgages purchases that are at or below their local area median home price.

Hensarling’s bill, which went nowhere when the Democrats ran the House last year, would also require minimum down payments of 5% for all new loans purchased or guaranteed by Fannie and Freddie in the first year after its enactmentl. That would go up to 7.5% in the second year and 10% in the third year.

Some Republicans are also backing the Treasury’s recommendation that Fannie and Freddie should raise the fees it charges for guaranteeing credit risk. The Obama administration contends that a hike in fees charged by Fannie and Freddie would make it more expensive to buy government-backed mortgage securities and, as a result, drive investors to buy private-label residential mortgage-backed securities.

The approach is something top Republicans are backing in theory as well, including Rep. Randy Neugebauer (R., Texas), the new chairman of the oversight and investigations subcommittee of the House Financial Services Committee.

On another front, Republicans are also generally opposed to the Treasury’s recommendation that Congress consider creating a catastrophic-risk insurance fund. Rep. Scott Garrett (R., N.J.) indicated that he was opposed to it, arguing that the government’s track record in pricing risk has been “extremely poor.

“The Deposit Insurance Fund, the National Flood Insurance Program, and the Pension Benefit Guaranty Corp. are three government insurance programs that historically have terrible records of properly pricing for risk,” Garrett said.