U.S. Treasury Secretary Timothy Geithner.KEVIN LAMARQUE
With the legislative overhaul of Wall Street finished, the Obama administration is preparing to take on an even greater challenge that it can no longer avoid: finding a new way to underwrite the American dream.
Treasury Secretary Timothy Geithner will assemble a dozen specialists this week for a major conference to help determine the future of the government-backed housing enterprises commonly known as Fannie Mae and Freddie Mac, which so far have cost the government some $150-billion (U.S.) to keep solvent.
Fannie and Freddie exist to make it easier for Americans to buy homes, white-picket fences optional. Despite their weakened status as wards of the state, the two companies remain central to $12-trillion mortgage market because private lenders want little long-term exposure to a business where the value of the principal asset - houses - is declining.
Created by Congress yet controlled by private shareholders until they were bailed out two years ago, Fannie and Freddie have a mandate to expand the mortgage market by purchasing home loans from financial institutions, relieving those lenders of the risk of holding onto the loans and freeing up money for them to sign up more homeowners.
Fannie and Freddie generate revenue by repackaging their loans as mortgage-backed securities and selling them to investors.
Anyone who has taken even a fleeting interest in the causes of the financial crisis knows that this uniquely American model of sanctioning private companies to fulfill a social mission went horribly wrong.
Seeking return for shareholders and personal enrichment for themselves, the companies' executives took advantage of the perception that lending money to Fannie Mae and Freddie Mac was as risk-free as buying Treasuries. The two companies used the cheap money to buy more and more loans, including subprime mortgages. Politicians were happy because home ownership rates were climbing. Shareholders were happy because Fannie and Freddie resold the mortgages at much higher rates than their own cost of borrowing.
But it all came crumbling down when it turned out that the people behind all those subprime mortgages that Fannie and Freddie absorbed couldn't afford them. The administration of George W. Bush was forced to take over the companies in the autumn of 2008, and President Barack Obama has continued to plow billions into the companies to cover their losses from record home foreclosures. Unlike with U.S. banks, there seems little prospect of the government getting any of that money back.
Mr. Geithner has promised to present Congress with a comprehensive plan by January. The deadline, which allows Democrats to avoid taking a stand on housing policy until after the November mid-term elections, reflects the sensitivity of an issue that is woven into the American cultural fabric.
In the years preceding the financial crisis, former Federal Reserve chairman Alan Greenspan, Mr. Geithner's predecessors at the Treasury Department and others warned that Fannie Mae and Freddie Mac were ticking time bombs. Yet the political will to tackle the problem didn't gel until after they blew up.
"It used to be that anyone who said they would reform Fannie and Freddie was characterized as anti-housing," said Phillip Swagel, a professor at Georgetown University in Washington, D.C., and a former chief economist at the Treasury during the Bush years. "In September of 2008, when they got in such bad shape, that political support evaporated."
But a consensus that there's a problem doesn't mean there is agreement on a solution.
Republicans would privatize Fannie and Freddie, a move that could result in higher mortgage rates because the companies would lose the government backing that allows them to borrow more cheaply than other financial institutions.
(Pacific Investment Management LLC co-founder Bill Gross, who manages the world's biggest bond fund and will participate in Mr. Geithner's conference, told the Financial Times last week that without government backing for mortgages, he would require borrowers to make down payments equal to 30 per cent of the value of the loan.)
Senator John McCain of Arizona and other Republicans tried to include Fannie and Freddie in the broad overhaul of financial regulation, but were rebuffed by the congressional majority.
The issue is less clear-cut for Democrats, who count as their constituents anti-poverty organizations that point out that Fannie and Freddie, despite their flaws, provide significant support for low-income housing.
Mr. Geithner has given no hint on what he will propose. He's getting a lot of suggestions: a request earlier this spring for ideas on how to change housing finance resulted in more than 300 submissions. The Washington Post reported earlier this month that if there were a theme to the recommendations, it was to leave Fannie and Freddie in place as heavily regulated agencies that offer insurance for high-quality mortgages.
Prof. Swagel's proposal is similar. Unlike many Republicans, he says there is a role for government in the housing market. While Prof. Swagel would make Fannie and Freddie unambiguously private companies, he would at the same time offer government insurance for securities backed by mortgages taken out by worthy borrowers.
The cost of that insurance would ensure taxpayers get some return for underwriting the mortgage market. To lower mortgage rates, he would encourage banks and other financial institutions to compete with Fannie and Freddie.
"It's pretty well acknowledged, whether you like it or not, there will be a role for the government in housing finance," Prof. Swagel said.