US housing finance: Sharp splits presage slow revamp

The Obama administration plans to lay out its vision for overhauling the US housing finance system later this month, but the gargantuan undertaking could take years given sharp ideological differences on Capitol Hill and the fragility of the housing market.

Republicans took control of the House of Representatives last week and have vowed to end the government's involvement in the $11 trillion U.S. residential mortgage market.

While they are likely to fall somewhat short of that lofty campaign promise, some tightening of home-loan terms is all but certain in the next few years as the government pulls back its support for the largest housing market in the world.

The plan Treasury Secretary Timothy Geithner is expected to unveil will be the next step in a debate over the future of Fannie Mae and Freddie Mac, the two ailing firms that continue to prop up the housing sector by providing the bulk of funds for US home mortgages.

Policy makers on the left and right agree on the need to revamp the mortgage finance system, but they disagree on how.

Many Republicans want to move to a completely private market that does not use taxpayer funds to help homebuyers. Democrats generally support some government support to lower the cost of homeownership.

In the end, Fannie Mae and Freddie Mac could be broken up to make way for smaller firms.

The ultimate outcome of the debate could affect tens of millions of homeowners.

"Is the middle class going to have a homeownership option going forward, or is homeownership going to become a luxury?" is how David Abromowitz, a partner at the Goulston & Storrs law firm and a senior fellow at the left-leaning Center for American Progress, frames the debate.

Breaking up Fanne, Freddie

Geithner has said he sees some need for a government role in the housing market, which could face further sales and price declines if the support were retracted entirely.

"There is a strong case to be made for a carefully designed guarantee in a reformed system with the objective of providing a measure of stability in access to mortgage finance even in future economic downturns," he said last August.

Fannie Mae and Freddie Mac, which were seized by the Bush administration in 2008 as mortgage losses mounted, have been the main players in the government efforts to foster homeownership. Since being seized, they have been propped up with more than USD 150 billion in direct taxpayer aid.

The two congressionally chartered companies buy mortgages from lenders and then repackage them as securities to sell to investors, thereby ensuring a steady source of liquidity for the market. They also hold mortgages in their own portfolios.

Their charter, and the implicit guarantee of a government backing that accompanied it, allowed the firms access to cheaper funds than their competitors, which boosted their profits and enriched their shareholders in good times.

A number of industry groups and policy think-tanks believe the two companies could be replaced by a handful of new firms that would take over their securitization role. However, unlike Fannie Mae and Freddie Mac, these firms would not be able to hold securities in their portfolios, lowering their risk profile.

These new firms would also be required to maintain a "capital cushion" to offset possible losses. In addition, investors buying their securities would need to put money into a rainy-day fund. If the capital cushion were depleted, the fund would back the securities, not the firms.

While any changes could take years to be worked out, homeowners can expect to be saddled with bigger downpayments, higher closing costs and higher interest rates when the process finally draws to a close.