The Obama administration is considering an overhaul of Fannie Mae and Freddie Mac that would strip the mortgage finance giants of hundreds of billions of dollars in troubled loans and create a new structure to support the home loan market, government officials said.
The bad debts the firms own would be placed in new government financial institutions -- so-called bad banks -- that would take responsibility for collecting as much of the outstanding balance as possible. What would be left would be two healthy financial companies with a clean slate.
The moves would represent one of the most dramatic re-orderings of the badly shattered housing finance system since Washington-based Fannie Mae was created by Congress to support mortgage lending during the Great Depression. Both Fannie Mae and Freddie Mac of McLean, Va., have government charters to buy home loans from banks, which they then repackage and sell to investors. The banks can then use the proceeds to offer more loans to home buyers.
The leviathans became emblematic of the financial crisis when they were in effect nationalized in September amid a market meltdown that revealed much of their holdings to be troubled. The government has since pledged more than $1.5 trillion, including $85 billion in direct aid, to keep the mortgage market working through Fannie Mae and Freddie Mac.
The proposal, which is preliminary and one of several under discussion, is scheduled to be taken up today by the White House's National Economic Council.
"It should come as no surprise that the administration is thinking through" wholesale changes to these companies, said Andrew Williams, a Treasury Department spokesman. "We are in the preliminary stage of the process, the systematic development of options has not taken place, and no decisions have been made."
Internal discussions over the future of the companies began this year during the regulatory reform planning process and are entering a more serious phase. National Economic Council Director Lawrence H. Summers has long wanted to overhaul the firms.
The government's efforts so far "have taken the risk out of those two firms," Treasury Secretary Timothy F. Geithner said in a recent interview. "The only question that remains is what form, what structure they ultimately will take."
In an interview Wednesday announcing that he would step down this month, James Lockhart, the chief regulator of Fannie Mae and Freddie Mac, said there needed to be a "good bank, bad bank" structure.
The "bad bank" would be a depository for Fannie Mae's and Freddie Mac's toxic assets. Then, the government could create new companies, if it chose to do so, that would attract private investment in support of mortgage finance.
Options for the "good banks" include consolidating the firms into a single government agency, leaving mortgage finance purely to private banks or maintaining a hybrid model.
The National Economic Council has looked at the "bad bank" option, among many others, in several internal policy papers. Any final decision would come after talks involving the White House, the Treasury Department, the Department of Housing and Urban Development and the Federal Housing Finance Agency.
A major problem has been that the firms own and insure trillions of dollars of existing mortgages. With the economy still in a deep recession, joblessness rising and defaults on home loans expected to continue to increase, there is great uncertainty over the size of future losses at Fannie Mae and Freddie Mac. That, in turn, is likely to drive investors from committing money to the companies.
Fannie Mae and Freddie Mac existed for years as odd hybrids, created by the government to support housing but owned by private shareholders. (They are now majority-owned by the government.) Over the years, the unusual status has fed concerns that the firms exploited their quasi-governmental role to borrow money at very low rates and therefore grow far larger than was sustainable. At the same time, they had a duty to shareholders to maximize profits, leading them to take on bigger risks.
Until the future of the firms is worked out, the Obama administration has been using them to carry out its housing recovery program, including restructuring mortgages to avoid foreclosures.
In addition, the Federal Reserve has bought well over $1 trillion worth of mortgage-related securities and debt from Fannie Mae and Freddie Mac. That further helped lower interest rates on home loans. The government also has pledged up to $400 billion in direct investment in the firms.
Summers has long thought that the old structure of the companies posed a danger to the financial system. In 1999, when he was Treasury secretary, he warned lawmakers that Fannie Mae and Freddie Mac had grown so large that if they stumbled, the damage to the economy could be staggering.