WASHINGTON (Reuters) - The U.S. government-run mortgage finance firms Fannie Mae and Freddie Mac could play a bigger role in turning around the battered U.S. housing market, the Federal Reserve told Congress, a call that looks set to run into stiff political opposition.
The Fed, in a paper sent to lawmakers on Wednesday, outlined an array of steps that could be taken to help the housing sector, including allowing Fannie and Freddie to provide cheaper mortgages to a broader pool of homeowners.
The two companies, the biggest sources of U.S. mortgage funding, were seized by the government in 2008 when they were on the brink of collapse. They have been propped up by $169 billion in taxpayer aid since then, making them a target of many on Capitol Hill.
Even the Obama administration, in a trio of alternatives laid out early last year to reform the U.S. mortgage finance system, supported reducing the government's role in housing finance.
"It comes at a time that Congress has become quite skeptical of Fannie and Freddie and their role, and seems to be looking for ways to diminish their long-run role in housing finance, not increase it," said David Resler, chief economic adviser at Nomura Securities International.
While legislative steps are likely off the table, the Fed's recommendations left plenty of scope for other approaches and could add to pressure on Fannie Mae's and Freddie Mac's regulator, the Federal Housing Finance Agency, to take a broad view in helping housing markets recover rather than focusing narrowly on stemming losses at the firms.
The Fed's proposal to expand Fannie and Freddie's role in the government's main refinance program was among a number of measures the U.S. central bank recommended aimed at bringing down the inventory of unsold homes, making it easier for borrowers to get credit and containing an onslaught of foreclosures.
"Continued weakness in the housing market poses a significant barrier to a more vigorous economic recovery," the Fed said in the paper, which was sent to the chairman and ranking minority members of the Senate and House of Representatives banking committees.
The Fed also said a government-facilitated program to turn real estate that banks have taken over into rental properties might be beneficial.
The Obama administration has already signaled an intention to sell off properties Fannie Mae and Freddie Mac hold to investors who are willing to turn them into rental properties.
Fed Chairman Ben Bernanke, in a letter accompanying the recommendations, said the U.S. central bank was responding to requests for advice about what could be done to halt the spiral of falling home prices and rising foreclosures.
Among the recommendations: allow Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB) to refinance loans that they have not guaranteed.
The United States, the world's largest economy, has yet to engineer a convincing recovery from the worst recession in decades, in part because of the depressed housing market that has experienced declines not seen since the Great Depression.
House prices have fallen 33 percent from their 2006 peak, resulting in an estimated $7 trillion in household wealth losses. Currently, about 12 million homeowners are underwater on their mortgages nationally, and in states experiencing the largest house price declines, roughly half of all mortgage borrowers owe more than their homes are worth.
Fannie and Freddie, government-sponsored enterprises (GSE) that are chartered by Congress, buy loans from lenders and repackage them as securities for investors, which they then guarantee. The aim is to provide a steady source of funds for the mortgage market.
Many Republicans accuse the companies of having fostered the shoddy underwriting practices that led to the financial collapse. However, the firms had drawn scrutiny long before the crisis because lawmakers believed their implicit government backing gave them a competitive edge in the mortgage market.
The Fed estimates expanding their authority could allow an additional 1 million to 2.5 million borrowers to refinance loans into lower interest rates through the government's Home Affordable Refinance Program. So far, only about 925,000 mortgages have been refinanced through the program.
Although the GSEs would take on added credit risk by expanding HARP to non-GSE loans, the broader benefits might offset some of the costs, the Fed said.
However, the recommendations also pit the Fed against Fannie Mae and Freddie Mac's regulator in a debate over what is more important: stemming losses at the GSEs or the overarching goal of restoring health in housing markets.
"Some actions that cause greater losses to be sustained by the GSEs in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery," the Fed's paper said.
Some of the Fed's proposals, including a shift in the way the firms handle mortgages that go into default, could be put in place with the consent of the regulator, without congressional action.
"It is particularly telling that the white paper calls for regulators to evaluate their options on a more macro level rather than simply base evaluations on short term gains or losses," Senate Banking Committee Chairman Tim Johnson said in a statement.
The Fed said one factor causing tighter credit is the tendency of Fannie Mae and Freddie Mac to return mortgages to lenders if they see any defects. While that has limited the GSEs' need to draw on Treasury aid, it has also discouraged lenders from originating new mortgages, the Fed said.