WASHINGTON — Given the high expectations, and long wait, surrounding the Obama administration's proposal to create a new housing finance system, it was likely inevitable that it would disappoint.
Critics said the plan — which offered three options but declined to endorse a single way forward — was tepid, scant on key details and, in the words of Sen. Richard Shelby, "lacked a sense of urgency."
Although the decision to punt the decision back to Congress was not a surprise, some observers had at least held out hope that the administration would offer concrete, innovative ideas rather than vague concepts outlining the size of the government's footprint in the mortgage market.
"Our country deserves better leadership to resolve the ongoing mortgage crisis," said Jeremiah Buckley, a partner at BuckleySandler. "We cannot keep kicking the can down the road. Congress urgently needs to turn its attention to restructuring our nation's mortgage finance system and it deserves clearer recommendations than it has yet received from the administration."
The white paper left plenty of unanswered questions about what its recommendations say about its eventual plans, why it took the steps it did and what the future of the housing system will look like. We offer some answers to the following frequently asked questions.
Why did it avoid endorsing a single plan?
Politics. The Obama administration is between a rock and a hard place, namely the Republican-controlled House and the Democratic-controlled Senate, not to mention the plethora of industry actors like the National Association of Realtors, mortgage lenders and banks. Any plan it suggested was almost certain to be hammered by all sides. Offering just vague directions on the way forward makes it easier to please the various competing constituencies while also appearing like they are moving forward.
"The administration needs to politically show that it's making progress," said Jaret Seiberg, an analyst with MF Global Inc.'s Washington Research Group. "This is the way to do that without having a plan that's going to be deemed dead on arrival."
What's the administration's defense?
It's twofold. On the one hand, Treasury Secretary Tim Geithner said Friday they didn't need to deliver a concrete plan, since the Dodd-Frank Act enacted last year only asked the administration to offer options. For another, he argued that they are moving the ball forward by eliminating two options off the bat: full privatization and full nationalization of the housing market. He added that the mortgage market needs more time to work through its issues and banks and lenders need to worry first about compliance with Dodd-Frank.
The administration also points to other immediate steps it plans to make, including lowering the conforming loan limit, reducing Fannie Mae's and Freddie Mac's mortgage portfolios and raising the size of the Federal Housing Administration's premium.
Wait, those last steps sound familiar.
Much of this was already mandated by law, and isn't new. The conforming loan limit is due to drop to $625,000 from $729,000 on Oct. 1, while both government-sponsored enterprises are already required to reduce their mortgage portfolios. The administration has also twice raised the FHA premium and intends to increase it again by an additional 25 basis points when it releases its 2012 fiscal budget on Monday.
So what were the three options it suggested?
All three would call for the unwinding of Fannie and Freddie and a significantly scaled-back government role in the market. The first option would create a privatized system where government backing would be limited only to the FHA and other programs. The downside of that would be reducing access to mortgage credit and increasing the difficulty for homebuyers to obtain a traditional 30-year fixed-rate mortgage.
The second option would be roughly the same, but include a guarantee mechanism that in times of emergency would be grown to fill the gap left by the exit of private capital. This would mean the government could help in a crisis, but also largely returns the market to private hands.
A third option would be dismantle the GSEs and reduce the government's role, but create a catastrophic reinsurance plan. Under this scenario, a group of private mortgage guarantor companies would provide guarantees for securities backed by mortgages that meet strict underwriting standards. A government entity would then provide reinsurance to the holders of the securities, which would only be paid if shareholders were entirely wiped out. The government would charge a premium for its reinsurance which would be used to offset losses to taxpayers.
So which option does the administration like?
Probably the third, although administration officials are forthright that all three options are imperfect. Ostensibly, it didn't endorse any of the plans, but most observers see the third option as the most practical for several reasons. For one, both options one and two run the risk of eliminating the 30-year fixed-rate mortgage, the traditional form of mortgage credit in the U.S. While some Republicans have suggested the country would be OK without that type of loan, big players in the mortgage market are likely to fight tooth and nail any attempt to restrict or eliminate it.
"I think the administration, out of the three options, favors the third because it's phrased in the most positive way," said Karen Shaw Petrou, managing director of Federal Financial Analytics. "If you wanted a 30-year fixed-rate mortgage you would have to do something with a government guarantee."
Is that the only reason?
No. As the administration acknowledges, option one does not allow the government much leeway to step in in the event of a future crisis. During the current crisis, the government has been one of the only reliable ways to access mortgage credit. Without it, many agree most mortgages would not have been available during the past two years.
Option two theoretically gives the government a way to step in with some kind of guarantee, but the details of that have yet to be spelled out. The administration's paper essentially said it sounds like a good idea, but did not offer any sense for how it would work in practice.
There are also fears that options one and two will simply concentrate power in the mortgage market with the largest banks.
"If there is absolutely no government role in creating liquidity for a secondary mortgage market, community banks will be shut out of the mortgage financing business," said Cam Fine, the president of the Independent Community Bankers of America. "Community banks do not have the means to portfolio long-term fixed-rate loans, and do not have the volume to securitize mortgages on their own."
Who else likes the third option?
Plenty of market players have suggested versions of it. The Housing Policy Council, which publicly endorsed the third option on Friday, has called for the creation of a Federal Deposit Insurance Corp.-like system to backstop mortgage-backed securities. Administration officials used similar language to describe option three when they presented it to reporters. Two Federal Reserve Board economists have also endorsed a similar approach.
So the third option is it?
Not so fast. There are still significant problems with the third option, including how the government would establish a price for its guarantee. Some Republicans have already said it is little better than the current system because it leaves the taxpayer potentially on the hook during another crisis. What happens next?
Unfortunately, while Fannie and Freddie collapsed two and a half years ago, the debate over their future has really only just begun. The administration has not addressed the trickiest problem — where to draw the line for government involvement.
"If you answer it from an economic perspective, privatization is very attractive," said Brian Harris, an analyst for Moody's Investors Service. "You don't have a subsidy theoretically for the housing market. If you want to answer the question from a public policy perspective, you get a different answer. If you are trying to maximize both sides it is difficult because they are conflicting objectives. You can't fully reduce taxpayer exposure and fully maximize access to credit. There has to be somewhere where there is exposure and acceptable reduction to credit. This paper doesn't go into answering that question of what is an acceptable level of taxpayer exposure and acceptable availability of credit."