Fannie and Freddie's Open-Ended Future

Once the current solvency crisis has passed, should the mortgage giants be officially nationalized, tightly regulated, or sold off?

By Jane Sasseen

Treasury Secretary Henry Paulson's surprisingly aggressive move to essentially nationalize, if only temporarily, struggling mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) raises a host of questions, not least of which is how much it will ultimately cost U.S. taxpayers to bail them out. But the biggest question of all centers on how the two entities should be restructured once the immediate solvency crisis is past.

While the fate of Fannie and Freddie will not be decided until a new Administration and Congress take office, the battle lines already are being drawn. Critics have long argued that Fannie and Freddie were doomed by their odd hybrid nature as semipublic, semiprivate enterprises: The mortgage companies were supposed to earn rich profits for shareholders even as they were expected to foster public goals like keeping the mortgage market liquid and making homeownership affordable for millions of Americans. Now policymakers, backers, and critics alike have begun to weigh in on what promises to be an enormous fight over the future status and role of Fannie and Freddie.

"There is no script for this," says Howard Glaser, a senior housing official in the Clinton Administration and the former top lobbyist for the Mortgage Bankers Assn. who now runs the Glaser Group. "This debate is going to be front and center whoever comes in next year."

While both of the Presidential candidates pronounced themselves in support of the emergency bailout, the two men have very different views of the long-term role the mortgage companies will play. Republican contender John McCain was quick to argue that the mortgage giants should be shrunk down and privatized once they return to health. His opponent, Democrat Barack Obama, has stressed that the government must move carefully to ensure that whatever changes are made don't cause further disruption to the housing and financial markets.

Here's a look at three options being discussed in policy and financial circles, and what each would mean:

Stick with Uncle Sam

Given the inherent conflict the mortgage giants face in trying to meet public policy goals while keeping private shareholders happy, one camp argues that the firms should be officially nationalized. Fannie and Freddie would then become government agencies focused solely on their public mission of providing liquidity to the housing market and to promote homeownership for low-income Americans—much like Fannie was until 1968, and like Ginnie Mae, which securitizes Federal Housing Authority loans, has always been. Under this scenario, Fannie and Freddie would no longer be allowed to invest in mortgage-backed securities for their own portfolio—the primary source of their current problems.

A downside of this approach, however, is that the two entities may have trouble recruiting strong executives and managers. Political interference could also become worse. "There's a danger that they become even more susceptible to political pressures and pork barrel projects than they already have been," says Robert Litan, vice-president for research and policy at the Kauffman Foundation.

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