What a plan to replace Fannie and Freddie should include

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Wednesday, January 12, 2011; 7:33 PM

WE ARE ABOUT to find out what the Obama administration proposes to do about the nation's mortgage finance system. By the end of January, it must produce a long-term plan for replacing the failed government-sponsored enterprises, Fannie Mae and Freddie Mac, which back about half of the $10.6 trillion in outstanding residential mortgages and - in combination with other federal agencies - more than 90 percent of all new home loans. The administration has put this off for months, plausibly pleading concern for the fragile housing market. But now it faces a congressionally legislated deadline, which is just as well: The current situation, in which the moribund government-sponsored enterprises (GSEs) hemorrhage cash and the U.S. Treasury covers their losses, cannot go on indefinitely.

Treasury Secretary Timothy F. Geithner seems likely to favor a more specific version of the reform he sketched last year: a government guarantee "in a reformed system, with the objective of providing a measure of stability in access to mortgages, even in future economic downturns." Unlike the implicit government guarantees that Fan and Fred so ruinously enjoyed, this would be an explicit and limited guarantee, sold by the government to regulated securitizers of qualifying mortgages.

One big issue for any such proposal would be to decide which private entities, and how many, could enter the business; yet another challenge, as Mr. Geithner conceded, would be "to make sure that any government guarantee is priced to cover the risk of losses, and structured to minimize taxpayer exposure." Whatever Mr. Geithner suggests, the next move will be up to Republicans in Congress; we'll see whether the GOP holds out for its preferred solution - a purely private market in mortgage securitization - or heeds powerful real estate lobbies that want continued government help. Meanwhile, the Obama administration can and should start to shrink the GSEs by gradually raising the fees they charge for securitizing loans and by reducing the maximum size of those loans.

The good news is that there's consensus about why and how the GSEs went wrong. They enjoyed a perceived but not explicit federal guarantee, which enabled and encouraged them to raise cash at favorable rates and then gamble their borrowings for the benefit of their private shareholders. Another historic mistake - for which politicians of both parties were responsible - was to assign the GSEs explicit targets for supporting loans to low-income borrowers. This, plus the drive for profit, drew them deeper and deeper into subprime mortgage-backed securities, which ultimately caused 70 percent of the GSEs' recent losses, according to the Congressional Budget Office. At last count, those losses had cost taxpayers $134 billion.

Whatever else the Obama administration and Congress decide, surely they should agree to make any successors to Fannie and Freddie pure providers of mortgage liquidity - free of risky credit allocation mandates. If the federal government wants to support low-income home ownership, it should do so explicitly, through the Federal Housing Administration and similar on-budget agencies. Public purposes such as this are best pursued publicly.


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