NEW YORK -- The Obama administration outlined three options Friday to change the way home loans are financed, calling for the slow death of mortgage giants Fannie Mae and Freddie Mac and jumpstarting the debate over the future role of government in helping borrowers secure mortgages.
If implemented, the proposals would likely make it more expensive for borrowers to buy a home and thus restrict the availability of mortgages. It also marks a significant departure from past government policies, which treated homeownership in America as a virtual right.
"The government must...help ensure that all Americans have access to quality housing that they can afford," the administration said in its report to Congress, delivered as part of last year's financial overhaul law. "This does not mean our goal is for all Americans to be homeowners."
The troubled housing market -- a legacy of the deep bust that followed a historic boom in which reckless lending and borrowing led to the most punishing downturn since the Great Depression -- led to calls for the federal government to radically reform the way home mortgages are financed. There's $10 trillion in outstanding home loan debt.
Policy makers, bankers and investors agree that taxpayer-owned Fannie and Freddie should be wound down. But there's no consensus on what should replace them.
The first option outlined in the report calls for a private system in which lenders and investors fund new mortgages, with a limited role for existing federal agencies to subsidize home loans for the poor and other special groups, like veterans. The second proposal calls for much of the same, but it includes a government backstop for mortgages during times of market stress. If credit markets froze -- like they did at the height of the crisis -- the government would step in and guarantee new home loans. The third option outlines a much broader government role. Under this alternative, taxpayers would insure securities backed by home loans, which is what Fannie and Freddie already do.
The administration's outline explained the benefits and costs of the various options, but stopped short of endorsing any of them. Critics will likely say the administration punted.
The 31-page outline says "very little that is surprising or market-moving as it lacks specific details or...any extreme views," mortgage bond strategists Greg Reiter and Jeana Curro at RBS Securities wrote in a note to clients. They were "mildly surprised" at the lack of details, though.
Analysts at Amherst Securities, led by Laurie Goodman, said in a report that the plan is "largely a non-event."
Along with federal agencies, taxpayer-owned behemoths Fannie Mae and Freddie Mac guarantee more than nine of every 10 new mortgages. They were effectively nationalized in 2008. Delinquencies on home loans they back have thus far cost taxpayers more than $150 billion. Their regulator, the Federal Housing Finance Agency, estimates Fannie and Freddie could need up to $363 billion in taxpayer cash through 2013, it said in an October report.
"We are going to start the process of reform now," Geithner said in a statement. "But we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market."
Geithner said it will take another three years for the housing market to recover. It currently suffers from a high foreclosure and delinquency rate, low levels of homeowner equity, and an abundance of homes for sale without a corresponding number of interested buyers.
After that, it will likely take two to three years for policy makers to come to agreement on the government's role in funding home loans, Geithner said. The final step calls for new legislation. All told, Geithner said it will take between five to seven years to transition to a new system.
Steps to take during that time to slowly wean the market off total government support largely revolve around making Fannie- and Freddie-backed mortgages more expensive, which would make loans not backed by taxpayers more desirable. This includes increasing the fees Fannie and Freddie charge to guarantee home loans backing securities; pushing them to require homeowners to purchase additional mortgage insurance or put at least 10 percent down; and reducing the size of individual loans that Fannie and Freddie could guarantee.
But while the administration wants to decrease government's role in funding home loans, it wants to increase federal subsidies for rental housing. Shaun Donovan, the secretary of the Department of Housing and Urban Development, said Friday that half of renters spend more than one-third of their income on housing, and one-quarter of renters devoted more than half, according to HUD research.
Reactions from lawmakers ranged from pleasant surprise to muted displeasure.
Rep. Barney Frank of Massachusetts, the top Democrat on the House Financial Services Committee, praised in a statement the administration's support for increasing resources directed towards renters, but said it is "not clear" whether lenders and investors alone could support the market in a way that makes mortgages affordable to borrowers.
Rep. Ed Royce, a Republican from California who also serves on the financial services committee, said he was "pleasantly surprised" that the administration wants to wind down Fannie Mae and Freddie Mac.
"The 800-pound gorilla in the room remains the level of government support in the mortgage market going forward," Royce said in a statement. "On that front, [the Obama administration] decided to punt."
Rep. Maxine Waters, a California Democrat and another financial services committee member, said she has "concern" that the administration's proposals "may radically increase the cost of homeownership, and housing in general."
The theme of the report and subsequent conversations with administration officials stressed the Obama team's desire to have a smaller government footprint in the mortgage market.
"The report's takeaway message is that the U.S. housing finance system is likely to undergo major changes going forward, and with the likely outcome being a significantly smaller role for the U.S. government," analysts at research firm CreditSights said in a note.
The reality is Democrats want continued government support of mortgages backing securities.
A fully privatized system would lead to higher costs for mortgages, but it would also nearly extinguish the risk posed to taxpayers and would enable resources currently devoted to housing to go to more productive channels, benefitting the economy in the long run, the administration noted in a nod to the predominant Republican position.
A hybrid approach that calls for increased government support during times of market stress would enable the government to lessen the social costs from contractions in credit to borrowers. Maintaining government backing of home loans at all times ensures cheap mortgages, thus artificially inflating home prices and allowing resources to continue flowing to housing. This proposal also puts taxpayers on the hook for losses.
But while observers say the administration appears to favor a robust government role -- analysts at RBS Securities say government-sponsored entities and federal agencies will likely end up supporting 50-65 percent of the market -- it's not clear that one is needed.
Firms would package home loans into bonds and Investors would buy them absent government guarantees, market participants said Friday. Mortgages would be more expensive, but only compared to today's historically-low prices. Over time, they'd moderate to average levels, they said.
In effect, Democrats' argument that the cost of mortgages would skyrocket lacks merit, they said.
"The notion that the cost of these products would be extraordinarily high is predicated on the notion that we continue to accept no down payments on loans," said Joshua Rosner, managing director at independent research consultancy Graham Fisher & Co. and one of the first analysts to identify problems at Fannie Mae and Freddie Mac.
Brett D. Nicholas, the chief investment and operating officer at Redwood Trust, a California-based real estate investment firm, said that with taxpayers backing 95 percent of new home loans "there is no room for the private sector."
"It's a circular argument to say that, 'Well, the private sector is not there so oh my God rates are going to go up hundreds of basis points,'" Nicholas said. "It's just not true." One basis point equals 0.01 percentage point.
"The fact is the private sector is there," Nicholas added. "We have capital. Lots of firms like us have capital. There's trillions of dollars of demand from life insurance companies, banks, [and] mutual funds."
Last year, his firm sponsored the only private-sector security backed by new home mortgages and sold to investors. The deal contained more than $200 million worth of jumbo mortgages, industry parlance for home loans too big to be backed by the Federal Housing Administration, a government agency, or Fannie Mae and Freddie Mac.
"The dollars are there," Nicholas said. "There's just no loans to sell to [investors] because they're all going to Fannie, Freddie and FHA."
Rosner said that if borrowers start putting down 20 percent of the purchase price, investors would price in lower risks of default and snap up the securities.
He added that getting borrowers to put that much down is good for the economy because it gets consumers in the habit of saving more and only being willing to buy a home once they were sure they could afford it.
This would lessen the risk of a housing collapse and minimize costs to taxpayers, Rosner said, as opposed to the administration's preferred approach of a continued government role, which he argues simply continues the current system of privatized gains and socialized losses.
"The administration is still not thinking of ways to incent proper behavior," Rosner said. He added that the tax code could bring about many of his recommendations.