WASHINGTON — Most top lawmakers and President Obama agree that Fannie Mae and Freddie Mac should be unwound, but cleaning up the government-sponsored enterprises is a challenge unlike anything the government has attempted before.

So far, the debate has mostly focused on what replaces the GSEs, rather than exactly how they should be taken apart. Yet the mechanics could have a large impact on the mortgage market and whether a bill can attract the necessary political support to pass.

"I don't think this part of" the reform plan "has really been completely fleshed out partly due" to the fact that "winners and losers are going to have to be chosen," said Edward Mills, a financial policy analyst at FBR Capital Markets.

Fannie and Freddie have operated under government control since their operations were seized in 2008. But despite concerns from some corners, the House and Senate bills currently gaining traction among lawmakers would go a step further and officially eliminate the GSEs.

Under both bills, the government would continue to back all of the firms' outstanding debt and mortgage-backed security obligations — without adding new business — until the GSEs are erased.

"It's like a bad bank without the good bank structure," said Mark Calabria, a former staffer on the Senate Banking Committee and now director of financial regulation studies at the Cato Institute.

Despite agreement between House and Senate lawmakers on that approach, however, such a move could prove controversial.

Both bills include some elements common to Federal Deposit Insurance Corp. seizures of failed banks, including the creation of bridge entities to manage the two firms' remaining assets, in resolving Fannie and Freddie. But a key exception — illustrating Fannie and Freddie's unique and notorious role in the financial system — is that the legislation proposes making all creditors completely whole.

That may prove politically unpopular when more attention is focused on that issue, yet anything else could spark opposition from the financial markets.

"Maybe from a political perspective, you would like to avoid someone getting paid 100 cents on the dollar. But from a market perspective you don't want that to be the reason why GSE reform doesn't happen," said Mills.

The 100% backing for what are technically unsecured creditors is yet another confirmation of the unprecedented support Fannie and Freddie get from the government. Creditors in bank failures and insolvencies of other companies typically expect haircuts.

But observers said the bills reflect an acceptance of the GSEs' federal guarantee, and is likely meant to move the debate toward creating a new system less dependent on the government.

Others said providing less than full backing in the GSE wind-downs could be disastrous. Lawmakers who passed the Dodd-Frank Act were stingier in provisions authorizing the FDIC to resolve failed financial conglomerates, allowing the agency to impose haircuts on creditors. The earlier 2008 law that created the Federal Housing Finance Agency, and which governs the current conservatorships of the GSEs, also withheld full backing for creditors in a failure scenario. Similar to FDIC receiverships, that law essentially granted the FHFA power to determine the order of creditor claims.

"In the wind-down of a big bank under Dodd-Frank, the goal would be to … eliminate guarantees as much as possible," said Michael Krimminger, a former FDIC general counsel and now a partner at Cleary Gottlieb Steen & Hamilton. "Here, because of the central role played by the government-sponsored enterprises within the housing finance structure, the government can't afford to walk away from guarantees on mortgage-backed securities that had been issued by Fannie Mae and Freddie Mac and then adopted by the conservatorship. That would create a systemic unwind."

But Krimminger noted the blanket coverage makes sense for other reasons. With Fannie and Freddie in conservatorships, it is difficult to justify haircuts for investors who essentially purchased debt that finances the government's control of the two companies.

"For those who bought bonds or mortgage-backed securities after the initiation of the conservatorship, it's the same thing as somebody who buys an obligation of a bridge bank," he said.

Overall, both bills largely track each other in how the entities are unwound.

The House bill, co-authored by Financial Services Committee Chairman Jeb Hensarling, would require the FHFA to exercise its receivership authority no more than five years after enactment.

The FHFA would then be authorized to create a "receivership entity" to temporarily hold the firms' remaining assets and liabilities. Fannie and Freddie's charters would be revoked, but payments of obligations for outstanding debt issued by the GSEs, capital leases and MBS guaranteed by the mortgage companies would still be honored. Those obligations would be backed by the "full faith and credit of the United States."

Similarly, the Senate bill would shutter Fannie and Freddie, but require the repayment of debt obligations as well as obligations to holders of MBS. Those obligations would be backed by the "full faith and credit" of the government.

"Even though the GSEs are put into 'receivership,' their existing obligations are given unique protection not contemplated for any other type of" systemically important financial institution, "because Fannie and Freddie are not any other type of SIFI," said Karen Shaw Petrou, managing partner at Federal Financial Analytics.

Petrou added that the fiscal implications of that coverage may start to get more attention as the GSE debate continues.

"If you give Fannie and Freddie that explicit guarantee for all their existing obligations, what's the budget impact of that? It's huge," she said. "These days … budget impact is a serious policy and political issue."

The Senate bill would likely leave some of the GSEs' existing infrastructure as part of the proposed Federal Mortgage Insurance Corp., a new entity that would provide a government backstop to private mortgage-market participants. (Under the Senate bill, private investors would take a 10% first-loss position before FMIC would provide a guarantee.)

Some observers suggested that regulators implementing the House bill could also opt to preserve some of the GSEs' existing infrastructure in the legislation's proposed National Mortgage Market Utility, which would help referee a new private mortgage market without providing any government guarantees.

"In the Senate version, there is plenty that gets unwound but a lot of it is just transferred to the FMIC," Mills said. "One of the undercurrents of the debate in DC has been: the name on the door versus the infrastructure behind the product. Everyone is in agreement about removing the name on the door, and there is almost near universal agreement that most of the infrastructure that exists today is worth preserving. Even the House bill that gets rid of a government guarantee still has a 'utility' function."

Under the Senate bill, the FHFA would handle the wind-down until the FMIC is certified. The government would be able to create a holding corporation and dissolution trust fund to manage distribution of the GSEs' assets and liabilities.

Meanwhile, the Senate version also authorizes the FHFA to determine payments to Fannie and Freddie shareholders, in consultation with Treasury and the FMIC, from any proceeds of winding down the two companies. Preferred shareholders would stand in front of common shareholders. (The Treasury, as the primary shareholder for both companies, would be first in line to recoup any proceeds from the resolutions.)

Krimminger said rewarding shareholders with any proceeds at the end of the resolution would be standard procedure. "If there is enough money to pay shareholders, that can even happen in a bank receivership, and it has happened. It's not very often, but it does happen," he said. "The assets and liabilities of the GSEs are significantly different from those of a bank, but the process for the resolution and clearing up the assets and liabilities should be similar to any insolvency process."

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