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Fannie Mae and Freddie Mac reform: Would it add $5 trillion to US debt?

The Obama administration held a conference Tuesday about how to reform mortgage giants Fannie Mae and Freddie Mac. Reform could involve adding Fannie and Freddie's roughly $5 trillion in obligations, in effect, to the federal balance sheet.

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The battle in Congress, expected to ramp up early in 2011, will reflect a sharp partisan split that's existed for years. Republican lawmakers emphasize the importance of scaling back government's role in the housing market and limiting taxpayer exposure to losses. Many Democrats emphasize the risks of providing too little support for the housing market, given housing's prominent role in family wealth and in the economy's ups and downs.

Both sides of this debate were represented in Tuesday's panel discussions. Many participants from the private sector – including Mr. Zandi – said the government should eventually scale back its role in the housing market significantly.

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At the same time, many said government mortgage guarantees should continue to be available in some carefully managed forms.

At least one participant, bond-fund manager Bill Gross of the investment firm PIMCO, suggested that government guarantees should apply to virtually all mortgages. He said this results in mortgage interest rates that are about 3 percentage points lower than if the only mortgage insurance came from the private sector.

Whatever role the governemnt takes in the future, policymakers must also decide on a transition plan to get there.

Many panelists urged that Fannie and Freddie should not be reconstituted in something similar to their pre-crisis form: profit-seeking private corporations that, at the same time, have a government-chartered mission and implicit taxpayer backing.

An exit strategy could involve adding Fannie and Freddie's roughly $5 trillion in obligations, in effect, to a federal balance sheet that already includes $13.3 trillion in federal government debts. The GSE obligations would be a different animal, because those liabilities would need to be covered by taxpayers only if things went bad in the housing market.

But the nation has just seen things go bad in the housing market.

During the financial panic of 2008, investors who held GSE debts became increasingly worried about the solvency of those corporations. The Bush administration felt impelled to put Fannie and Freddie into a conservatorship, to avert a possible bankruptcy and to keep mortgage markets moving.

The companies weren't holding enough capital in reserve to cover likely losses.

As of March 31 this year, 6.3 percent of mortgages held by Fannie and Freddie are either seriously delinquent or in foreclosure. Although that's down slightly from the figure three months earlier, it represents a big one-year rise (from 3.9 percent in early 2009).

In the end, losses to Fannie and Freddie related to the financial crisis may cost taxpayers $305 billion, according to one estimate recently published by Mr. Zandi and Alan Blinder of Princeton University. But that figure could rise or fall depending on what happens with the economy – and with government policies on housing.