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WASHINGTON (Reuters) - Mortgage financiers Fannie Mae and Freddie Mac would be liquidated within five years and replaced by an entity offering government reinsurance for mortgage-backed debt under draft legislation from a bipartisan group of U.S. senators.
To protect taxpayers from having to absorb losses incurred during periods of economic stress, the senators are considering requiring private financiers to take a first-loss position, according to the 100-page-plus draft bill obtained by Reuters on Tuesday.
The behind-the-scenes effort in the Senate to shutter the two government-sponsored enterprises is being led by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner. Their work is viewed as a serious first step in a debate over the future of the housing finance system that could go on for years.
U.S. lawmakers across the political spectrum have a goal to reduce the government's role in housing finance, but disagree on how to find the right balance.
"We continue to believe that GSE reform may not cross the finish line until after the next president is inaugurated," Jaret Seiberg, a senior policy analyst at Guggenheim Securities wrote in a client note.
The discussion draft of the bill, circulating among senators in an effort to gain support, would establish a new federal mortgage insurer that charges and collects fees in exchange for providing catastrophic insurance.
The corporation would support securitization and act as a reinsurer. In the event of a default that exceeds the first-loss position of private stakeholders, the corporation would cover shortfalls in payment of principal and interest under the loans gone bad.
When Fannie Mae and Freddie Mac are shuttered, the U.S. Treasury Department would be required to absorb their outstanding obligations, according to the draft. The two companies, which were seized by the government in 2008 as mounting mortgage losses threatened their solvency, own or back about half of all U.S. home loans.
The new government reinsurance entity, called the Federal Mortgage Insurance Corp., would offer a backstop on mortgage-backed securities in the event catastrophic losses swamped private creditors at a time of severe economic stress.
It would build a common securitization platform and also help community banks and smaller lenders who do not have the capacity to issue mortgage-backed securities on their own.
It would charge and collect fees designed to cover both its operating costs and to maintain a catastrophic fund.
The draft bill, first reported by Bloomberg, said revenues from a liquidation of the two companies would first be used to repay the government for its stake in the companies, with any remaining funds going to junior preferred shareholders and finally common shareholders.
The government has an 80 percent stake in each firm, with the U.S. Treasury holding about $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares. It also has warrants to purchase common stock.
Many analysts said it was unlikely any funds would remain beyond what would be needed to repay the government.
Investors, including some hedge funds, have been buying up both common and junior preferred shares of Fannie Mae and Freddie Mac in the hopes lawmakers will draft legislation that does not wipe out current shareholders.
Fannie Mae and Freddie Mac have drawn almost $190 billion in taxpayer aid and, by the end of June, will have paid the Treasury about $132 billion in dividends.
The two companies buy mortgages and package them into securities, which they issue to investors with a guarantee. They also sell debt to help fund their mortgage purchases.
After years of red ink, they have now returned to profitability. The terms of their bailout do not allow them to buy back the government's stake, which means they will keep making dividend payments as long as they are profitable without ever recovering the loan amount.
Reporting By Margaret Chadbourn; editing by Andrew Hay