CBO Outlines Options for Fannie/Freddie

As the government moves forward on plans to reform the national mortgage system, one big unknown remains. Make that two unknowns: Fannie Mae and Freddie Mac. Given that these two entities currently underwrite almost every mortgage, how they are dealt with has vast implications for the future of mortgage lending.

Since 2008, both Fannie and Freddie have been in government conservatorship, and have absorbed nearly $ 150 Billion in (mostly unrecoverable) taxpayer funds. Ironically, their role in the mortgage finance system has only increased over that time. When you account for indirect lending (via the FHA, VA, Ginnie Mae, etc.), Fannie and Freddie now underwrite more than 90% of all residential mortgages. Their combined portfolio exceeds $ 4 Trillion, or more than half of outstanding mortgages. Everyone recognizes that the current arrangement is unsustainable, but there is tremendous disagreement over what should be done.

The Congressional Budget Office (CBO) recently published an excellent report, which outlined three basic options. Under the first scenario, Fannie and Freddie would remain public institutions, backed by an explicit guarantee. The program would be funded by charging fees to borrowers, and any losses/subsidies would be recorded in the federal budget. The main advantage is liquidity, while disadvantages include increased government control (this is subjective) and risk/costs borne by taxpayers. The second option would be to spin off, wind down, or completely eliminate Fannie/Freddie and allow private lenders and investors to take control of mortgage lending. This system would spread out risk and encourage “prudent behavior,” but might prove to be unviable, especially in times of crisis. In addition, given the importance/scope of mortgage lending, investors might continue to assume an implicit government guarantee.

The CBO devoted the most space to the third option, a “hybrid public/private model.” In practice, this scenario would closely resemble the pre-credit crisis state of affairs, differing mainly in that Fannie/Freddie (or the institutions that replace them) would have an official  – rather than implicit – government guarantee of some kind. This could take the form of a government insurance program, government support of specific types of mortgages, and/or an agreement by the government to step in if there was a crisis (i.e. if the national default rate ever exceeded a sudden pre-defined threshold). In this way, the government could continue to stay involved in the mortgage mortgage in order to facilitate liquidity for all residential mortgages, as well as to implement other housing policy objectives.

This general idea has gained the most traction, and is the one that is ultimately most likely to be adopted when Congress takes up the issue. When the Republicans won control of Congress, it was expected that dealing with Fannie/Freddie would be a major priority. Since then, Congress has become distracted by other issues. Besides, everyone recognizes that the role of Fannie/Freddie is currently so outsized that any change to the status quo would basically cause mortgage lending – and by extension, the housing market – to collapse.

While it’s possible that a soon-to-be-released Treasury Department report will provide a timetable in reform, it seems that for now, the system will remain in place, and Fannie/Freddie will continue to suck in taxpayer money at the rate of $ 10-20 Billion per year. Given that the conservatorship’s charter expires in 2012 and that the current system is becoming further entrenched, Congress only has so much time to come up with a solution.