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New Effort to Reform US Mortgage Banks

By Gina Chon, Financial Times

A third bill will be introduced to the US Congress to tackle the last major remnant of the financial crisis: reform of the mortgage giants Fannie Mae and Freddie Mac.

Maxine Waters, the top Democrat on the House Financial Services Committee, is the latest lawmaker to put forward a plan to overhaul Fannie and Freddie. The final version will probably reflect a combination of at least two of the proposals.

Dealing with Fannie and Freddie is a priority since their continuing existence five years after the financial crisis in 2008, when they needed a $188bn bailout, is seen as unfinished business for policymakers.

But a lot more work needs to be done to get to an acceptable bill, meaning housing finance reform could be delayed until next year. Also, private capital has not returned to the housing market in a significant way, making Fannie and Freddie an important engine in mortgage financing. Last year, Fannie and Freddie provided support for about $1.3tn of the approximately $1.9tn in single-family home mortgages originated in the US.

The involvement of Fannie and Freddie, and the government guarantee that goes with them, has helped maintain the availability of a mainstay of American home buying: the 30-year fixed-rate mortgage. Fannie and Freddie buy mortgage loans and package them into bonds.

That is why, although it would close down the mortgage companies, the plan from Ms Waters would maintain government involvement through a guarantee, paid for by the mortgage industry, to capitalise an insurance fund. In place of Fannie and Freddie, it creates a new co-operative-owned mortgage securities issuer, according to her aides. The bill is still in draft stages.

The plan has some similarities to a bipartisan proposal from Republican Senator Bob Corker and Democratic Senator Mark Warner. That legislation sees Fannie and Freddie winding down within five years and establishes a government-managed insurance fund, similar to the role that the Federal Deposit Insurance Corporation plays in insuring bank deposits.

One of the criticisms of the Corker-Warner bill is that it requires private investors to take the first 10 per cent loss of the credit risk on mortgage securities, which some say is too rigid. The Waters bill would share the credit risk in a more flexible way.

The other plan comes from Financial Services Committee Chairman Jeb Hensarling, a Republican who envisages an essentially privatised housing finance system. But that plan jeopardises the 30-year mortgage, which makes it difficult for some politicians to support.

All of the proposals face the question of whether enough private capital is available to fill the gap if Fannie and Freddie are closed, given that banks have greatly reduced their exposure to mortgages. Capital from private mortgage insurers and private label securities is also not enough to support the $4.5tn in mortgage-backed securities guarantees from Fannie and Freddie.

That is why hedge funds and other private investors have pushed to keep Fannie and Freddie, but reform them. However, the two mortgage firms are seen as political hot potatoes, according to aides in Congress. Shutting down two symbols of the financial crisis is seen as a win that Congress needs, especially after the public opinion beating it took from the government shutdown stand-off.

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