On Friday, the Obama administration submitted a report to Congress on reforming the housing finance market, which consists of reducing the government’s footprint in the housing market by winding down the Government –Sponsored Enterprises (GSE) Fannie Mae and Freddie Mac.

Mortgage giants Fannie Mae and Freddie Mac provide liquidity to the mortgage market by  buying  mortgages from lenders and packaging them into securities for investors. After the U.S. real estate bubble burst in 2008, Fannie Mae and Freddie Mac were placed into conservatorships under the Federal Housing Finance Agency (FHFA) to provide stability to the housing market.

The report contains three alternatives for a future housing market with varying degrees of government involvement.  All three alternatives provide government support for programs that assist lower-income borrowers to secure affordable housing:

• Option 1: Privatize the housing market in which the government’s involvement is limited to programs that specifically target low and moderate-income borrowers, such as  the Federal Housing Administration (FHA), the U.S. Department of Agriculture and  the U.S. Department of Veterans Affairs. This option reduces taxpayer exposure and minimizes distortions in capital allocation, however, it reduces access to mortgage credit;
• Option 2: In addition to option 1, the  government would also  develop a backstop mechanism to ensure access to credit in the event of another housing downturn.; or
• Option 3: In addition to option 1, the government would offer an insurance backstop, through reinsurance, for mortgage-backed securities.

The administration also offers some of the following changes to immediately  reduce the government’s involvement in the housing market:

• gradually increasing minimum down-payment requirements on loans guaranteed from Fannie Mae and Freddie Mac to 10 percent.  Currently borrowers can make a smaller down payment if they purchase mortgage insurance;
• reduce maximum loan limits that Fannie Mae and Freddie Mac can purchase.  The administration proposes to allow current maximum loan limits, which are at $729,750, to expire on October 1. This will put high-priced loans into the private market;
• gradually increase the guarantee fees so that private guarantors would be able to better compete;
• require Fannie Mae and Freddie Mac to obtain more private capital to withstand future housing downturns;
• more conservative underwriting standards that require homeowners to hold more equity in their homes;
• wind down Fannie Mae’s and Freddie Mac’s mortgage portfolios, by at least 10% per year; and
• consider merging federal mortgage agencies.