The Obama administration has signalled that the government should no longer play a major role in the U.S. housing market - a seismic shift that could eventually topple a system that dates back over seven decades.
Two pillars of housing finance in the U.S. - troubled mortgage giants Fannie Mae and Freddie Mac - will be slated for demolition, according to proposals released Friday calling for an "orderly and deliberate wind-down" to their vast operations.
Such a prospect remains fraught with difficulty. In the aftermath of the financial crisis, the two government-backed bodies have taken on an even larger role in the housing market as private-sector players fled from the business of buying up mortgages. Steps to reduce their activities could bring further distress to an already struggling sector.
What's more, getting rid of Fannie and Freddie will require legislative action. There's no guarantee that a divided Congress would be able to reach a consensus on such a sensitive topic, especially with elections looming in 2012.
Without Fannie and Freddie in the picture, mortgages will become more expensive and less available than they have been in the past - the stuff of political dynamite.
Resolving the fate of the two housing giants remains the chief unfinished business of the financial crisis. They became wards of the government in 2008 and have received $150-billion (U.S.) in bailout money.
Treasury Secretary Timothy Geithner said Friday the overhaul would proceed with caution, but urged legislators to take action soon. "We are going to start the process of reform now, 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," he remarked in a statement.
Created in 1938, Fannie Mae was conceived as a way to expand home ownership in the aftermath of the Great Depression (its nickname springs from its official name, Federal National Mortgage Association). Freddie Mac was born in 1970 as the Federal Home Loan Mortgage Corp. (its moniker flows from the shorthand "fed mc," and became its official name in 1997). The two firms carved out a critical role in the market for mortgages: buying qualified home loans and repackaging them into securities which Fannie and Freddie guaranteed, relieving the burden of risk from lenders. Last year the government guaranteed more than nine in 10 new mortgages.
While the two firms succeeded at fulfilling their mandates, they suffered from an internal contradiction that would prove their undoing. They operated as for-profit companies but were viewed by investors as government-backed entities. In 2006 and 2007, they plunged into the business of backing risky home loans, with disastrous results.
The Obama administration's proposals, revealed in a white paper Friday, are only the first salvo in what is likely to be a long debate. The paper presented three broad paths for how to proceed, all of which foresee a significantly diminished role for government in the mortgage market and the demise of Fannie and Freddie.
In the first scenario, the government would only guarantee mortgages for limited groups of borrowers, leaving the "vast majority" of the market to the private sector. That option comes with a price: reduced access to home loans for many Americans. "In particular, it may be more difficult for many Americans to afford the traditional … 30-year fixed-rate mortgage," the paper said.
The second option would also leave most of the market to the private sector, but envisions a way for the government to increase its role in guaranteeing mortgages during times of economic stress. The third proposes that the government act as a "reinsurer" of some mortgages, acting as a backstop to private players in the event of a crisis.
Friday's report does not provide a road map or timetable for implementing any of the proposals. The politics of such an overhaul are daunting, analysts say, and will provoke opposition from smaller banks, developers, real estate brokers, and consumer groups. Supporting a change that will eventually mean higher mortgage rates "is a tough vote for many lawmakers regardless of their party affiliation," wrote Jaret Seiberg of MF Global earlier this week.