WASHINGTON — The housing bill has been law for just a week, but the next big fight over the government-sponsored enterprises is already brewing.
The Housing and Economic Recovery Act of 2008 tightened oversight of the GSEs but also gave the Treasury Department the power to buy Fannie or Freddie stock and to lend an unlimited amount to either company.
These changes are prompting people on both sides of the debate to ask whether the GSEs' public-private business model — which pits profit-seeking shareholders against an affordable housing mission — needs adjusting.
"Obviously, keeping it the same is not viable," said former Federal Reserve Board Vice Chairman Alan Blinder, now a professor at Princeton University. "Given that taxpayer money is at risk, that in itself calls for a heavier hand from government."
Policymakers face three basic choices — nationalize, privatize, or keep the current structure. Each option carries significant downsides.
Just how bad things are at both companies should become clearer this week as each reports second-quarter results: Freddie today and Fannie on Friday. Both are expected to post a fourth consecutive quarterly loss. Just how bad the June 30 numbers look could influence the debate over an appropriate business model.
"If earnings stay in the sustainable but limping along category, it certainly avoids the imminent action that far more serious problems would" suggest, said Karen Shaw Petrou, the managing director of Federal Financial Analytics.
Steve O'Connor, the senior vice president of government affairs at the Mortgage Bankers Association, said policymakers must confront the issue.
"It has long been an issue of some controversy, but the [Treasury authority] brings it back to the fore as a matter that has to be considered," he said. "There's still that undercurrent of the two masters they're trying to serve simultaneously."
Privatizing a GSE is no small task, as Sallie Mae proved. Privatizing the student lender took seven years to completion in 2004.
Judy Kennedy, who led Sallie Mae's government relations team from 1991 to 1997, said it would be far more difficult to privatize Fannie and Freddie.
"It was a whole lot easier when Sallie was solvent and at the top of its game," said Ms. Kennedy, who also worked at Freddie and now leads the National Association of Affordable Housing Lenders.
"But this crisis, and the potential cost, is staggering," she said. "It sort of brings home, in the ways Sallie Mae never could, the cost of government sponsorship."
Housing advocates argue that privatization would reduce liquidity in the mortgage market. Some see regulation, not the business model, as the problem.
"There's no question that both Fannie and Freddie have been a cornerstone of the American dream and contributed to widespread homeownership," said Jim Carr, the chief operating officer of the National Community Reinvestment Coalition. "The challenges that we face recently have less to do with its model and structure and have everything to do with regulatory oversight."
If privatized, Fannie and Freddie would downsize their business, most observers said they expect. In part, this is because, without the government's implicit backing, raising funds to support their current size would cost more. The GSEs would probably trim their mortgage portfolios, which critics have long argued create systemic risks.
But privatized GSEs would also enhance competition, Prof. Blinder said.
"If you do the privatization route, at least you get the benefits of competition," he said. "One argument that's been made by the critics of Fannie and Freddie is that the implicit guarantee creates an unfair advantage and made for a noncompetitive market."
Joseph Mason, a finance professor at Louisiana State University, favors privatization, arguing that the current model, coupled with the new Treasury powers, fosters moral hazard.
"Suppose that if I was to give you a guarantee in writing that I would cover your debt if you went bankrupt and impose no restrictions on you whatsoever, you would have every incentive to apply for new credit cards and buy a new house and leverage up as much as you could," he said. "Which just increases the likelihood that the blowup will be even bigger."
But nationalization presents its own challenges.
Though the Treasury Department has winked in the direction of nationalization, the GSEs remain off the government books. Full-scale nationalization would increase the national debt, whose ceiling Congress was forced to increase by $800 billion, to $10.6 trillion, in order to accommodate the Treasury's new GSE powers.
Though Fannie and Freddie have their problems, even critics say they are far more efficient operations than traditional government agencies.
"With nationalization, I would just say look at" the Federal Housing Administration, Mr. Carr said, referring to an agency that has been criticized during the subprime meltdown. "I don't think anyone would want to see Fannie or Freddie turn into another FHA."
Prof. Blinder said the word "nationalization" alone is a problem.
"Nationalism evokes immediate negative connotations," he said. "Americans basically don't believe in socialism."
Former Treasury secretary Lawrence Summers has pushed for a hybrid business model. The government could put the companies into receivership with the ultimate goal of privatizing pieces of each GSE, he argued in a Washington Post op-ed last week.
Fannie and Freddie like the status quo, but Freddie sees more room for adjustments.
"The best course is to maintain the GSEs in their current form as shareholder-owned companies," a Fannie spokesman said.
A Freddie spokeswoman said, "The GSE model ha[s] served the nation and America's families well. It has helped bring stability and liquidity to the housing market, in good times and bad, and has made possible the long-term, prepayable, fixed-rate mortgage."
"That said," she continued, "the GSEs are a creation of Congress, and it is important that a debate on the efficacy of the model be based on facts and not on ideological views or the vested interests of particular market players."
Depending on how aggressive the new regulator is, the GSEs could face a de facto nationalization. The Federal Housing Finance Agency has the power to take over either company as well as the power to set executive pay, capital levels, and the products and services Fannie and Freddie may sell.
Debate over the public-private model is not new. The GSEs were just beginning to emerge from accounting scandals when the housing crisis struck last summer. Those scandals helped spark debate over whether Fannie and Freddie were paying too much attention to shareholders at the expense of their housing mission and ultimately led to the reform efforts included in the housing law.
Still, many observers agree it will take a big event to get Congress to act, such as the GSEs being forced to borrow from the Treasury.
"That would make it very real to members of Congress and many taxpayers," Prof. Blinder said.
Another trigger: one or both GSEs going into receivership.
"If these guys play so close to the edge that they go into receivership, that calls into question the fundamental aspects of the public-private model," said Thomas Stanton, a fellow of the National Academy of Public Administration. "If that happens...People will really be asking the question — 'do we need GSEs?' "