The Obama Administration took a wrecking ball to its dilapidated housing finance system yesterday by announcing plans to wind down Fannie Mae and Freddie Mac, the companies that own or guarantee more than 85 per cent of American mortgages.
The US Government seized control of Fannie and Freddie in 2008 as the two financing giants started stacking up heavy losses amid the collapse of the housing market. It has since poured in more than $130 billion (£80 billion) of taxpayer funds.
There has been widespread, bipartisan agreement that something must be done to extricate the State from ownership of the pair, known as government-sponsored enterprises (GSEs), and to gradually reduce its footprint in the mortgage market.
Outlining the proposals yesterday, Timothy Geithner, the US Treasury Secretary, said that in addition to winding down the GSEs, he planned to strengthen consumer protection and ensure that government support for affordable housing was better targeted.
However, he was vague about the timing, saying that the reforms could take five to seven years and would have to be phased in to avoid any shocks to the system. "We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market," Mr Geithner said.
His proposals aim to bring private capital back to the market by gradually raising the fees that the two GSEs charge for guaranteeing mortgages, to make privately backed home loans more competitive.
Under the plans, there would also be gradual increases in the minimum deposits required from borrowers to at least 10 per cent (smaller downpayments are possible for borrowers who take out mortgage insurance).
The report also includes proposals for enhancing borrower protections and improving the way in which lenders work with borrowers who fall behind on payments.
To achieve these aims, Mr Geithner has laid out three approaches. One would create an almost fully private system that would reduce the Government's role in the mortgage market by allowing the Federal Housing Administration to guarantee a small group of mortgages for low to middle-income borrowers.
The second would provide a government backstop primarily during periods of market stress, while the third would create similar backstops but also offer federal reinsurance for securities of certain mortgages.
Viral Acharya, Professor of Finance at New York University Stern School of Business, said that legislators faced a Catch-22 in pulling off the reforms: "The GSEs guarantee 90 per cent of new mortgages; until you get them out, you can't get private sector models in."
In the middle
Fannie Mae and Freddie Mac buy up mortgages and sell them on to investors as securities to free up cash for lenders to lend again
Investors have long assumed that the two government-sponsored enterprises have an implied federal guarantee and it is this that lets them borrow at more favourable rates
In 2008, the Bush Administration took them over after concluding that they did not have enough capital to continue to fund mortgages.