Senators launch effort to replace Fannie Mae and Freddie Mac

WASHINGTON — Nearly five years ago, the subprime meltdown triggered a huge taxpayer bailout of housing finance giants Fannie Mae and Freddie Mac.

Now a bipartisan group of senators has launched the most comprehensive effort yet to clean up the mess and dramatically reduce the government's role in the mortgage market.

Four Democrats and four Republicans want to shut down Fannie and Freddie over five years and replace them with a new government agency modeled on the Federal Deposit Insurance Corp. — one that would be funded by industry fees and play a much smaller role in guaranteeing mortgage debt.

The new Federal Mortgage Insurance Corp. would grow gradually as the government unwinds Fannie and Freddie. Since the 2008 financial crisis, the two financing giants, along with the Federal Housing Administration, have backed about 90% of all new home mortgages.

The plan unveiled Tuesday would reduce the risk to taxpayers if the housing market collapses again by forcing private companies — mainly banks — that package mortgages into securities to hold at least 10 cents in capital for every dollar of the underlying loans to cover the first wave of potential losses.

Had such a provision been in place in 2008, the bill's backers said, there would have been enough money to back Fannie and Freddie losses without the need for the government to pump $187 billion, to date, into the companies to cover mortgage guarantees.

"It lessens the footprint of the federal government in housing. It winds down Fannie and Freddie, but at the same time it keeps the housing finance industry in a liquid state," said Sen. Bob Corker (R-Tenn.), who is leading the group along with Sen. Mark R. Warner (D-Va.). "We believe it is time to act."

The bill's backers admit that the legislation is likely to undergo major changes before it could pass. It faces a significant obstacle in the House, where key Republicans have said they want to get the government completely out of the housing finance industry.

But the proposal helps spur the complicated process of deciding the fate of Fannie and Freddie and the role the government should play in the mortgage market. And it earned praise from analysts and market participants for providing a solid starting point.

The Senate Banking Committee is set to consider the legislation this fall, Corker said. All eight senators who helped craft the bill serve on the 22-member committee.

"This bill is significant because it represents the first serious effort to revamp the U.S. housing finance system since the government put Fannie and Freddie into conservatorship in 2008," said Jaret Seiberg, a senior policy analyst in Washington with financial services firm Guggenheim Partners.

But the hurdles are difficult. Seiberg said there was almost no chance the bill introduced Tuesday would become law as written and noted that the odds were against any type of broad housing finance reform legislation while Obama is president.

The process of overhauling the housing finance system will take several years, Seiberg said.

The housing market recovery makes it easier for the federal government to start pulling back its support for Fannie and Freddie even if banks balk at the idea of holding 10% in reserve for loans packaged and sold as securities.

But the rebound in housing prices also has created a problem for lawmakers.

Fannie and Freddie, which are under government conservatorship, have posted record profits. And under the complex terms of their bailout, those profits come back to the Treasury in the form of dividends.

As of March, the two companies had paid $65 billion in dividends to the government. And Fannie Mae is set to make an additional $59.4-billion payment by the end of the month.

The unexpected windfall has helped reduce the federal budget deficit and push back the date by which Congress must raise the nation's debt limit, making it harder to shut down Fannie and Freddie and close that spigot, the senators admitted.

But the government has to start pulling back its support for the mortgage market because taxpayers could be forced to pump more money into Fannie and Freddie if another housing downturn hits.

"Bottom line is, the taxpayer's still on the hook and we need to fix that, and that's what this bill does," said Sen. Jon Tester (D-Mont.), another backer.