Feb 9 (Reuters) - The Obama administration wants the private sector to play the dominant role in the U.S. residential mortgage market and is expected this week to unveil several scenarios for how that might happen.
More than 85 percent of U.S. residential mortgages are now backed by the government in some way. Republicans want to bring that down to zero, though they acknowledge such a transition will take time.
At its heart, the debate over what to do about major mortgage financing sources Fannie Mae FNMA.OB and Freddie Mac FMCC.OB is an ideological one: How much help should the government provide to the housing market?
Fannie Mae was established as a government agency in 1938 to support homeownership. In 1968, U.S. President Lyndon Johnson privatized Fannie Mae to take its obligations off the federal books and make the deficit look better amid high spending for the Vietnam War. Freddie Mac was later established as a competitor to Fannie Mae.
That government charter allowed the two firms to borrow funds more cheaply than competitors because investors assumed, though it was not written down, that the government would bail them out if they ever got into trouble. Investors were right: the government seized them in 2008 and they have since taken more than $150 billion in direct taxpayer aid.
Policymakers from both sides of the aisle agree a new system is needed. The debate is over what it would look like.
Following is an examination of the main issues under debate.
Should there be an explicit government guarantee for mortgages behind the charter for a new firm?
House Republicans want to eliminate the government backing altogether and say the private market can better price the risk of home mortgages than the government can.
Democrats see a need for government backing to make sure mortgages are accessible to middle-class Americans.
Analysts estimate that the 30-year fixed-rate mortgage, the most popular among U.S. homeowners, would cost between half a percentage point to 3 percentage points more than comparable loans backed by the government.
Mark Zandi, the chief economist at Moody's Analytics, pegs the impact at just under 1 percentage point. "Regardless of what policymakers say, global investors will almost surely continue to believe the U.S. government would backstop a badly foundering mortgage finance system," said Zandi, who has proposed a new hybrid system that explicitly charges for the guarantee.
Republican Representative Jeb Hensarling of Texas wants to eliminate Fannie Mae and Freddie Mac within five years. Under the proposal from Hensarling, the fourth-highest ranking House Republican, the government's conservatorship of the two firms would end within two years. They would then enter receivership or be placed back into the market for a maximum of three more years.
Democrats are more supportive of a longer time-frame for winding them down. Some industry proposals have pegged an eight-to-10-year time-frame and others suggest 15 years or longer.
The housing market is still in the midst of a serious correction and some economists expect prices to plumb new lows in coming months. The availability of mortgage credit has become very tight since the bursting of the housing bubble. The Mortgage Bankers Association sees mortgage lending falling this year to levels not seen since 1997. The Obama administration's proposals are expected to lay out three options for what could be done and provide visions for what would happen under each scenario. That multiple-choice format buys the administration more time before charting a specific course in hopes the market is less fragile when a new system is unveiled.
In exchange for their congressional charter, Fannie Mae and Freddie Mac were required to make a certain percentage of their loans to lower-income borrowers. As the private market for so-called subprime loans began to grow rapidly during the housing boom, the two firms lowered their lending standards to capture market share. Some Republicans blame those affordable housing goals for the financial crisis, though the Federal Reserve has said the goals were not the cause of the crisis.
ROLE OF FHA
Established in 1934, the Federal Housing Administration insures loans against default but does not make them directly. Still, that government insurance is a more direct involvement in the mortgage market than the indirect backing Fannie Mae and Freddie Mac provide by buying up mortgages and selling some of them to investors to help ensure a liquid mortgage market.
The FHA's market share of total new residential mortgages has jumped from just a few percentage points during the housing boom to more than 20 percent today. Both the Obama administration and conservatives want to reduce the role FHA plays in the mortgage market for healthy borrowers. As part of a budget plan it will issue on Monday, the administration plans to propose raising fees on FHA-backed loans as a way to prevent borrowers flocking to FHA as they move away from loans guaranteed by Fannie Mae and Freddie Mac.
At the end of the process, whenever that may be, it will be harder for average homeowners to get a mortgage loan. Just how much harder remains to be seen. (Reporting by Corbett B. Daly; Editing by James Dalgleish)