Treasury Secretary Tim Geithner offered a tentative road map Tuesday for fixing what he called America's "damaged" system of housing finance, symbolized by the financial woes of Fannie Mae and Freddie Mac.
The the task is one of the most difficult mop-up and reform operations arising from the mortgage crisis.
For now, Fannie and Freddie are losing lots of money, and are in a Treasury conservatorship that puts US taxpayers on the hook. At the same time, the Obama administration is relying on Fanny and Freddie, sometimes called government-sponsored enterprises (GSEs), to keep home loans available amid a historic housing-market bust.
In his testimony before the House Financial Services Committee, Mr. Geithner did not offer a detailed reform proposal, but outlined some guiding principles. Significantly, he did specifically reject some options.
He argued against what might be called the two extremes on the policy spectrum – nationalizing Fannie and Freddie as government agencies or ending any government role in mortgage finance. He also said he doesn't see much promise in "creating a whole new class of GSE's to compete with each other."
What other options would be left? Some in-between frameworks, in which government backing for standard mortgage loans would continue.
"Some government support, particularly through the provision of guarantees or insurance, can contribute to financial stability and help reduce booms and busts in home prices," Geithner said.
He predicted that Congress will decide that there's a good case for "a carefully calibrated guarantee, appropriately priced, that would continue in some form."
Fannie and Freddie play a central in mortgage markets by buying or guaranteeing millions of home loans made by other lenders each year. This is especially important in times of turmoil, when banks or mortgage brokers might not otherwise have funding to write new loans.
Geithner acknowledged that the hybrid status of Fannie and Freddie – a mix of private shareholder ownership with implicit government backing – has been a recipe for taxpayer risk and must be ended. He did not spell out exactly how. And he frustrated some congressional Republicans by not offering a timetable for reform.
But Geithner's written testimony laid out some general goals and principles for a GSE overhaul, including:
- Keeping mortgages widely available. "This credit should be available even when markets may be under stress, at rates that are not excessively volatile," he said.
- Reducing market risk. He said any system of housing finance should distribute risk in a transparent manner, rather than increasing the risk of a systemwide bubble and bust.
- Aligning incentives of lenders and others to focus on long-term viability rather than short term gains.
- Avoiding privatized gains funded by public losses. Any government-backed guarantees "should earn an appropriate return for taxpayers," he said.
Caution: tough work ahead
Translating those principles into a reform proposal will be a big job for Congress and the administration. The issue is politically contentious. Some lawmakers questioned the need for GSEs, citing nations that lack such enterprises and weathered the recession better than the US.
Congress is frustrated at the big taxpayer tab for bailing out Fannie and Freddie, who found themselves with too little capital to weather their recession-related mortgage losses.
When one committee member asked whether the GSEs' debts are now part of the US sovereign debt, Geithner framed his answer as a careful two-step – designed to neither put trillion-dollar liabilities officially on US books nor to scare the buyers of GSE investors, whose confidence is crucial for low mortgage rates.
The debts "are different" from Treasury obligations, Geithner said. But "we will make sure that [Fannie and Freddie] have the financial resources necessary to meet their obligations."
Many Democratic lawmakers say the economy would be hurt by a wholesale government retreat from mortgage markets.