Obama's Mortgage Reforms: Stronger Standards but Higher Costs

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The Obama administration has proposed a comprehensive revamp of the nation's housing finance business to reduce the nation's dependence on struggling government-backed enterprises Fannie Mae and Freddie Mac. But it's clearly expecting an uphill fight in Congress on virtually every detail of the plan, and so it has offered multiple policy options, essentially passing the political hot potato to the Republicans.

"This is a plan for fundamental reform," said Treasury Secretary Timothy Geithner in a statement that accompanied the reform proposals. He said the administration is proposing the "wind down" of Fannie and Freddie, strengthening consumer protection and preserving access to affordable hosing.

"We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market," Geithner said.

Up to $400 Billion in Losses

In the wake of the financial crisis, the private sector has essentially bailed out of housing finance. The government-backed enterprises Fannie and Freddie, and the Federal Housing Administration, now account for 90% of the market for home mortgages. But Fannie and Freddie have already run up $150 billion in losses, a figure that's expected to rise to between $300 billion and $400 billion when the final bill for the housing bubble is tallied.

Because of those huge losses, the is pressure on both sides of the political aisle to reduce the government's financial exposure to mortgages in the future. But the still-weak condition of the housing market makes it difficult to act without making things worse.

"This is going to encounter a lot of political opposition, not just from Democrats and Republicans debating it, but the whole issue of can we really do anything given the fragile state of the housing market," says Guy Cecela, publisher of Inside Mortgage Finance. "If we're worried about selling homes every month, how can we talk about raising the costs of mortgages or anything else that is going to slow down any sort of recovery?"

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The Obama administration proposals include raising the rates Fannie and Freddie charge to banks for loan guarantees to the same levels as private banks. Private mortgages for so-called jumbo loans, which are not covered by government guarantees, currently cost between 0.5% and 0.75% more than government-backed mortgages. So, if Fannie and Freddie's fees were to rise to the market level, mortgage rates across the U.S. might rise substantially.

The administration also proposed lowering the maximum value of a mortgage that can qualify to be federally backed from the current $729,750 to $625,500. That's a widely suggested move that would attract the private sector to make more loans in the upper range of the market. The proposal also called for Fannie, Freddie and the FHA to set a minimum down payment requirement of 10%. Currently, the agencies are authorized to make loans with no down payments at all.

The big issue is what to do about the government guarantee that assures investors who buy Fannie and Freddie mortgage bonds that the U.S. government will pay back the bonds in the event the underlying mortgages default. Because of that guarantee, Fannie and Freddie can offer lower interest rates than the private sector. Investors, especially foreign investors, were burned by subprime bonds during the financial crisis, and now they won't touch private mortgage bonds without a government guarantee.

Taking Loan Guarantees Private


"I don't think there is any question the administration wanted to throw this in the lap of the Republicans who control the House and say, 'Here are some of the alternatives. You pick one and try to defend it,'" Cecela says.

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Anthony Sanders, a professor of real estate finance at George Mason University in Fairfax, Va., says the Obama proposal sounds nice but is too vague to accomplish much. "They give the impression they might be open to getting rid of Fannie and Freddie, but they're saying let's first try returning them to their pre-bubble status," Sanders says. "The problem with that approach is that in 2002 they blew out of control and pumped trillions of dollars into the housing market. What's to prevent them from doing that again?"

Sanders says the government guarantee could be replaced by insurance companies backing private bonds, but this would cost consumers more and require stricter lending standards, such as a 20% down payment.

Both Cecela and Sanders say any effort to remove the government guarantee will be fiercely opposed by a wide range of special interests, especially by groups such as real estate agents and homebuilders who are struggling in the current housing market malaise.

How Many Years Will It Take?

"The traditional housing interests would like as much government support as possible and will argue you can't change government programs until the housing market recovers in two to three years," Cecela says.

The Obama proposal does not set a specific deadline, but indicates that it will take at least five years to implement some of the proposed changes.
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