Are Fannie Mae and Freddie Mac facing imminent extinction?

Some elected officials are agitating for that. At a hearing on Jan. 22, Rep. Barney Frank (D., Mass.) said the House Financial Services Committee this year will recommend abolishing the agencies and coming up with a new system of housing finance. Rep. Scott Garrett (R., N.J.), too, has expressed concern about the mega lenders. He responded to President Obama s recent proposal to put restrictions on banks by saying that any financial regulatory reform that does not address Fannie and Freddie is not true reform.

Such comments are setting the stage for a debate in the capital over how to at least revamp Fannie and Freddie, which operate as government-sponsored enterprises or GSEs. Until the financial crisis hit, both companies were privately owned but publically chartered. In September 2008, as the two lenders tottered on the brink of insolvency, they were placed into conservatorship (and effectively nationalized with the government taking an 80% stake). In spite of this recent history, Fannie and Freddie have taken on an ever-increasing role in the mortgage market as loan originators, since large banks are still reluctant to lend directly to homeowners. The companies share of the $11 trillion mortgage market is now 51.4%, up from 43% at the end of 2007, according to a Standard & Poor s report on the GSEs published Jan. 21.

Virtually every mortgage that s been made in the last year has been securitized by Fannie and Freddie because there s no demand by investors for those mortgages without a government guarantee, says Rebel Cole, a professor of finance and real estate at DePaul University.

The move to do away with the quasi-public institutions has been gathering momentum for some time with proposals circulating to either turn them into full-fledged government agencies or to privatize them. President Obama is expected to propose a plan for how and when the GSEs will emerge from conservatorship as soon as next month as part of the fiscal 2011 budget process. But the S&P report predicts that any major overhaul of the mortgage giants is a long way off. And in an interview with PBS on Jan. 21, Treasury Secretary Timothy Geithner said it was unlikely that the administration would push through legislation to resolve the Fannie and Freddie dilemma in 2010. Is it plausible to think that Obama will get rid of Fannie and Freddie even if things were good? I don t think so, says Cole.

Even if something is announced this year regarding Fannie and Freddie, 2010 and 2011 are likely to be transition years, says Vandana Sharma, a credit analyst at Standard & Poor s and co-author of the report on Fannie and Freddie. Until unemployment stabilizes and the economy stabilizes, it s hard to imagine you can move a $5.4 trillion gorilla, she says.

More importantly, the GSEs have become the primary administrators of the government s efforts to help borrowers. At a time when the government is trying to implement home-retention and foreclosure-prevention programs, they have these two entities that are very well set up to do that, Sharma says. Although many criticize the dismal results of the Home Affordable Modification Program (HAMP), about 70% of the modifications done in the third quarter of 2009 were for GSE mortgages, according to the S&P report.

Some analysts predict that the GSEs role in the housing market will only grow as the government continues and expands on its efforts to stem foreclosures and keep people in their homes. There s going to be a tsunami of foreclosures in 2010, and there s going to be another program to bail them out, says Cole. He says he expects the administration to have Fannie and Freddie purchase actual delinquent mortgages out of the mortgage pools that underlie mortgage-backed securities and then restructure these mortgages with some degree of principal reduction in order to make them more affordable for borrowers, which would effectively be a double bailout of both the securities owners and borrowers. (The fact that the current HAMP plan does not include principal reduction is a sticking point; some say it s the only way the loan modification initiative can be effective.)

So what could a new overhauled government housing agency look like?

Some don t see the need for a semi-government entity to make mortgages more available for prime borrowers. If a borrower is sufficiently creditworthy, I don t think they need a government-subsidized mortgage; they should be able to get a mortgage in the private market in normal times, says Radhakrishnan Gopalan, an assistant professor of finance at Washington University s Olin School of Business.

But, Gopalan says, one area where a government agency is needed is to promote home ownership for certain parts of the population or for certain regions of the country where the private market isn t willing to go.