When the Obama administration unveils its housing rescue plan on Wednesday, it is likely that the government-sponsored entities Fannie Mae and Freddie Mac will be part of the solution on some level. But should they be?

The GSEs' expanding financial hegemony has been debated for decades and is a hot topic again as economic conditions have worsened. Banking and finance experts revisited this issue during a provocative panel discussion at a housing conference conducted last week by New York University's Furman Center for Real Estate and Urban Policy. While each panelist offered varying possible scenarios for the GSEs' future, sustaining Fannie's and Freddie's once-dominating positions as secondary mortgage lenders wasn't one of them.

Even under a conservatorship controlled by the Federal Housing Finance Agency, Fannie and Freddie—along with the Federal Housing Administration (FHA)—are financing the vast majority of all mortgages these days, and their actions still wield considerable impact. Last Friday, the two GSEs announced they would suspend foreclosures and evictions of occupied properties through March 6 to give Obama's plan a chance to get rolling. And TheWashington Post reported yesterday that on April 1 Fannie and Freddie would start imposing far tougher credit-score and down-payment guidelines on borrowers, all of whom will also pay anywhere from 0.25 to 1.5 percentage points more in "delivery fees."

Such guidelines would be a far cry from the 1990s, when these GSEs served as robust instruments for achieving federal mandates to extend homeownership. Critics now argue that the GSEs, with their not-so-implicit financing guarantees from the U.S. Treasury, contributed to inflating the housing bubble.

A commentary that Forbes magazine posted on its Web site yesterday—written by Peter Wallison, a fellow at the American Enterprise Institute (AEI); and Edward Pinto, a mortgage finance consultant—points out that from 1994 to 2003, Fannie's and Freddie's purchases of mortgages as a percentage of all mortgage originations increased from 37% to an all-time high of 57%; that in 2000 and 2001, 18% of Fannie's originations—totaling $157 billion—were loans with FICO scores of less than 660; and that from 2005 through 2007, the GSEs purchased over $1 trillion in subprime and alt-A loans, pumping up the housing bubble and driving down mortgage quality.

AEI has long been one of Fannie's and Freddie's detractors, but none of their naysayers ever imagined the GSEs' downfall would be from credit risk. Indeed, one of the more surprising developments during this economic meltdown has been how the GSEs became "a giant risk turkey that has come home to roost," says Alex Pollock, an AEI resident fellow and former president of the Federal Home Loan Bank of Chicago, who was one of the NYU conference panelists.

Now, as de facto government housing banks, Fannie and Freddie "are technically insolvent," he states, so the U.S. Treasury Department will need to finance their debt to resolve the mortgage crisis. But Pollock thinks the "primary function" of the GSEs in the long run should be to securitize prime loans as privately owned enterprises. Their mortgage portfolios should also be turned over to private companies such as banks or REITs to manage, he says, and any remaining functions should be folded into other government agencies. The result: no more GSEs, says Pollock.

Another panelist, Dwight Jaffee, a professor at the University of California at Berkeley who co-chairs the Fisher Center for Real Estate and Urban Economics there, proposes that HUD take over Fannie's and Freddie's activities of guaranteeing and securitizing mortgages. Jaffee also thinks HUD is better suited to providing financing for low-income housing, although he also suggests that the GSEs' involvement in multifamily housing should be expanded. "Any surviving piece would be returned to shareholders after [the GSEs] get out of conservatorship," he said.

Jaffee is among the panelists who believe FHA might be a better alternative to either Fannie or Freddie for financing mortgages. "The one mistake FHA did not make was that it didn't underwrite subprime mortgages," says Jaffee. However, "investors will always gravitate to places with guarantees," cautions Robert Van Order, a former Freddie Mac economist who is now adjunct professor of finance at the University of Michigan. Van Order is alone among the panelists in not objecting to the GSEs retaining their basic structures. But he also calls for modifications that include requiring them to have more risk-based capital to deter Fannie and Freddie from venturing again too aggressively into guaranteeing exotic mortgages for high-risk borrowers.

John Caulfield is a senior editor at BUILDER magazine.

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