NEW YORK Fannie Mae and Freddie Mac, the two largest sources of U.S. housing finance, are facing major overhauls of their businesses after being seized by regulators worried the companies were on the verge of collapse.
Policy-makers are faced with thorny decisions on how the congressionally-chartered but shareholder-owned companies should operate in the future.
Most observers expect Washington to scrap the model that put Fannie Mae and Freddie Mac in the hands of investors but left the companies with a congressional mandate to lower the cost of homeownership.
The following scenarios, gleaned from comments by policy-makers and analysts, examine options for the future.
This might be the easiest option to implement and would return the companies to their origins as a government tool to nurture the housing market.
Shareholders have only had a stake in Fannie Mae and Freddie Mac for about 40 years. Before that, the companies were fully owned and guaranteed by Washington.
Under the current conservatorship, which is likely to last for years, Fannie Mae and Freddie Mac are effectively in government hands again. Policy-makers may choose to hold that status quo and formally eliminate the investors' interest in the companies.
PRIVATIZATION WITH PAYMENT FOR INSURANCE
Policy-makers might return the companies to investors and offer to insure Fannie Mae and Freddie Mac investments.
Washington could charge the companies a fee to underwrite their debt and some of their mortgage securities as a way to nurture the housing finance sector without standing squarely behind the companies. This idea, aired by Federal Reserve Chairman Ben Bernanke, would be akin to the Federal Deposit Insurance Corporation's protection of banks.
COOPERATIVES WITH LOOSE GOVERNMENT TIES
Fannie Mae and Freddie Mac could be run by the companies that sell them home loans. In such a cooperative arrangement, Fannie and Freddie would focus on long-term, stable business rather than maximizing profits. The federal government might still offer to insure the companies against the most catastrophic losses. This arrangement could be akin to the Federal Home Loan Bank system where a dozen regional lenders are jointly and severally liable for any one member's losses and the federal government acts as guarantor of the entire system.
Just like power and water companies that provide vital services, Fannie Mae and Freddie Mac could be run as private entities that have strong government oversight. The companies would aim to turn a profit and would have no government backing, but a conservative board would set earnings payments and customer fees.
PRIVATE MORTGAGE-FINANCE COMPANIES
Although Fannie and Freddie are in government hands, their regulator is still trying to keep their shares trading. The agencies could emerge as large mortgage finance companies that bundle home loans for investors and raise funds in the traditional capital markets. Without government ties, though, the companies would not have lower funding costs and so would not enjoy the competitive advantage as they do now. The federal government would also lose one of its most powerful tools for helping low-income home buyers.
While they are currently only a talking point on Wall Street, covered bonds could become a mortgage finance tool to rival the influence of Fannie Mae and Freddie Mac. Unlike traditional mortgage-backed securities, which are frozen blocks of home loans, covered bonds allow banks to manage a dynamic pool of mortgages. This financing tool is popular in Europe but has a weak foothold in the United States because of regulatory constraints and the competitive advantages of Fannie Mae and Freddie Mac. The fate of those companies will have a direct impact on the future of covered bonds.