New administration gets to restructure Fannie, Freddie

When the next U.S. administration grapples with how to remake Fannie Mae and Freddie Mac, pretty much everything will be on the table, from nationalization to an outright retreat from the mortgage market.

This week's dramatic seizure of the two mortgage giants is only an interim step, and it has unleashed a fierce debate over how much of a player Washington should be in the housing market.

"No one knows what the end game ... will be," explained John McIlwain, a senior fellow at the Urban Land Institute in Washington. "The future role of the federal government in the U.S. housing market is now squarely at issue."

Fannie Mae and Freddie Mac have become the de facto mortgage market. With a virtual retreat of the private sector from the secondary mortgage market amid the recent turmoil, the two lenders have become the only game in town, backing as many as three-quarters of all new U.S. home mortgages.

Pretty much everyone agrees that's unsustainable.

The two presidential candidates -- Democrat Barack Obama and Republican John McCain -- and their congressional allies disagree on how deeply the government should be involved in pushing home ownership.

Obama, and many Democrats in Congress, are still wedded to the idea that the U.S. government has a role in promoting home ownership, particularly in making the American dream of home ownership more affordable.

McCain and the Republicans want a dramatically smaller role for Fannie Mae and Freddie Mac, eventually privatizing the companies entirely and getting the government out of the business.

In an op-ed piece in The Wall Street Journal this week, McCain and his vice-presidential running mate Sarah Palin vowed to shut down any government entity that isn't serving taxpayers.

"We will make sure they are permanently restructured and downsized, and no longer use taxpayer backing to serve lobbyists, management, boards and shareholders," Mr. McCain and Ms. Palin wrote.

The ultimate objective is to get the companies "off the government books entirely," Douglas Holtz-Eakin, one of McCain's top economic advisers, told Fox News yesterday.

For starters, Holtz-Eakin argued Fannie Mae and Freddie Mac should separate their two key functions -- the conventional business of guaranteeing mortgages and the riskier business of investing in exotic mortgage products. Holtz-Eakin likened the second function to a hedge fund, where the lenders have no business being involved.

Obama's stand on the mortgage lenders is a bit murkier. But he doesn't talk about privatization. Instead, he has suggested that much tighter oversight and regulation could deal with most of the criticism of Fannie Mae and Freddie Mac's ambiguous hybrid model -- private companies with implicit government backing.

Austan Goolsbee, Mr. Obama's chief economic adviser, told Fox News the objective will be to get "away from a model in which we privatize the profits and socialize the losses."

The U.S. government has been a major player in the housing market since the Great Depression, when President Franklin Delano Roosevelt nationalized the mortgage market as part of his New Deal, creating Fannie Mae in 1938.

Over the years, the nationalization has given way to a hybrid model. President Lyndon Johnson privatized the company in 1968 in a bid to clean up a government budget, swollen by the Vietnam War. Two years late, he created Freddie Mac to enhance competition in the mortgage market.

This week's bailout is merely a transition to a new mortgage finance architecture.

The options range from merging Fannie Mae into the Treasury Department to turning over mortgage finance entirely to the private sector.

A more likely scenario, according to many analysts, is that at least some of the companies' operations will be entirely spun off. But the majority of their business -- guaranteeing mortgages in the secondary market -- would stay with the government.

"At least once a decade, all hell breaks loose in financial markets, and the only way to keep this turmoil out of the housing markets is for the federal government to step in," said McIlwain. "Fannie and Freddie have played this role very effectively for 70 years, in one way or another, and the fact that they failed this time is no reason for the federal government to abandon the concept."

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)