Proposal Seeks to Restrain Fannie Mae and Freddie Mac

by 21 Feb 2013

It may be difficult to envision the mortgage market in the United States operating without the massive loan guarantees extended by Fannie Mae and Freddie Mac, but such a vision is at the heart of a proposal that will be unveiled in the few days by a group of former lawmakers and government housing officials.

The proposal will come from the Bipartisan Policy Center, a think-tank and policy research group comprised of figures such as Mel Martinez, former Secretary of Housing and Urban Development (HUD), and George J. Mitchell, a retired Democrat from Maine who served in the Senate from 1989 to 1995. Under this proposal, Fannie Mae and Freddie Mac would be liquidated to recoup the bailout funds due to American taxpayers, and a new government-sponsored mortgage entity would be created to provide limited guarantees.

A Massive Mortgage Portfolio

Although Fannie and Freddie were publicly-traded corporations and Wall Street darlings prior to the disastrous collapse of the housing and mortgage markets in 2008, they have always enjoyed certain government protections due to their intrinsic role in the real estate economy of the U.S. They are currently under conservatorship by the federal government due to their last-minute financial rescue by taxpayers, but their roles in guaranteeing mortgages are believed to have kept the U.S. from descending into a full-fledged economic depression.

The secondary mortgage market in the U.S. deals primarily in mortgage-backed debt securities that would not be possible to create and trade without the guarantees from Fannie and Freddie. About 80 percent of mortgages would not be approved, closed or funded without a government guarantee from either Fannie or Freddie. Without these guarantees, the U.S. Treasury would probably not get involved in purchasing mortgage-backed instruments, which would send interest rates skyrocketing and create a general apathy in the home lending markets.

Encouraging the Assumption of Risks

The upcoming proposal has already garnered strong bipartisan criticism. The Federal Housing Finance Agency (FHFA) is working on slimming down the role of Fannie and Freddie in shouldering most of the ultimate risk in the U.S. mortgage markets, but retail lenders are still flocking to them despite higher fees and stricter guidelines. The Mortgage Brokers Association and the Federal Reserve Bank of New York have their own ideas about reducing Fannie and Freddie's role in the mortgage markets, but none are calling for a complete exit.

The Bipartisan Policy Center would like to encourage retail lenders and investors of mortgage-backed securities to take on greater risk and responsibility before the government provides a guarantee. Critics point out that such a policy will drive up borrowing costs, which will ultimately be passed on to homeowners.

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