LIVE: Fannie Mae, Freddie Mac -- Dead or Alive

The government wants to get out of the mortgage business. But can they do it without bringing a halt to what is already a stalled housing market?

This morning, industry leaders are discussing ways to reform Fannie Mae and Freddie Mac as part of the Conference on the Future of Housing Finance, which is being moderated by Treasury Secretary Timothy Geithner and Housing and Urban Development Secretary Shaun Donovan in Washington, D.C.

For more conference-related coverage on AOL Real Estate, read these columns by housing experts Alyssa Katz and Jeff Corbett.

Panelists include legislators, community activists, academics and bank executives, all of whom have an interest in the outcome of the reform process, including Barbara Desoer, president of Bank of America Home Loans; Mike Heid, co-president of Wells Fargo Home Mortgage; and Susan Wachter, a professor of Real Estate, Finance and City and Regional Planning at the University of Pennsylvania's Wharton School. Topics will cover housing finance reform and the broader financial markets, as well as housing policy goals.

When the financial fallout hit the market in 2008, the government bailed out Fannie and Freddie along with a lot of private banks. The banks have been able to pay back what it borrowed, but with Fannie and Freddie, the problems were so deep, the government is still pouring taxpayer dollars into the agency.

But that doesn't mean the system is repaired. Earlier this month, Geithner said, referring to Freddie and Fannie, "We have a system that obviously didn't work, and there are fundamental aspects of the current system...that require sweeping fundamental change." What kinds of changes might Geithner be referring to?

The government is in a tough spot regarding these agencies. While they don't actually make the loans, they do buy and insure mortgages from banks; the two government-owned enterprises currently buy or guarantee 90 percent of loans being issued.

However, the government can't just disband the agencies without providing alternatives, since large investors say they would stop buying mortgage bonds if the government is not backing them. That could cripple an already fragile housing market.
Guy Cecala, CEO and publisher of Inside Mortgage Finance, told WNYC radio that, along with FHA and VA loans, "without Fannie Mae and Freddie Mac, there would essentially be no mortgage market in the United States. And that has huge ramifications for the housing market and the overall economy."

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A scenario expected to be discussed at the conference is one where the big mortgage lenders, such as JP Morgan and Citigroup, among others, create a cooperative. The idea is to preserve a system that had, up until 2008, worked quite well. It will work in the same way as Fannie and Freddie, but instead of being publicly owned, it will be owned by the banks. Mortgages would come into this co-op, then go out as mortgage-backed securities.

The only role the government would have in this scheme is as an insurer -- for a price. The banks would pay the government for insurance, which would cover the loans if an extreme market condition kicked in -- perhaps one as extreme as what happened to the markets in 2008. But in this case, the banks, because they own these loans, the theory goes, would be policing each other to ensure that no one takes on the bad loans that got the market into the long-term mess. The cost of insuring these loans will most likely fall onto the borrowers, who might have to pay a higher interest rate. But with interest rates at historically low levels, an increase in the interest rate might be a small price to pay for a more stable housing market.

Of course, change never happens quickly, and no one expects any reform measures to happen overnight. But with a fragile housing market, any changes will be gradual, taking place over the next several years as the agencies and banks ease into new roles.

What those roles will be is still anybody's guess. But the government is taking a step in the right direction, acknowledging that it can't continue to fund money-losing agencies at taxpayer's expense. No one believes that Fannie and Freddie should go on operating as they have.

Tuesday's conference is just the beginning of what will be a long process of change, as the government sorts out what can work and what won't. Geithner, for one, believes the government can figure it out. When speaking to a gathering at New York University earlier this month, he said, "This isn't rocket science."
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