In a highly anticipated announcement, the Obama administration presented its plan on how it will minimize the government’s role in the mortgage business. While the announcement signals the beginning of a mortgage recovery, changes may produce higher mortgage rates and fees for borrowers.
Government support won’t be drastically reduced immediately as the administration explained that pull out will be gradual. Because borrowers have experienced tremendous turmoil with little options over the past few years, the administration suggested three options for reducing the impact Fannie Mae and Freddie Mac will have on the mortgage market.
Fannie and Freddie government bailouts have cost taxpayers approximately $150 billion with Republicans claiming that both mortgage programs were to blame for the 2008 economic calamity.
However, minimizing both programs won’t be a panacea. Former Assistant Treasury Secretary Michael Barr says, "Under any of the scenarios there's going to need to be more private capital in the housing system. That's going to mean more pressure on interest rates."
The Three Options
Obama’s three recommendations are meant to lay the groundwork for open discussion and eventually a resolution. Treasury Secretary Timothy Geithner explains that while the proposal is a jumping off point, the administration will need to have the approval of Congress before any concrete decision is made. Geither says that turnaround in the mortgage housing industry is at least five to seven years away and that the government must use the recommendations as more of a means to an end instead of having a “monopoly of ideas.”
"We're going to drive west without knowing where we're going," Geithner said. "Somewhere around Salt Lake City, we'll have to make a choice."
On Friday, February 11, 2011 Obama proposed three mortgage options:
- Limited or no government role in the mortgage realm with the exception of the Federal Housing Administration programs (FHA)
- Allowing the government to step in (guarantee of private mortgages) only when the market signals that it is in trouble
- Private mortgage companies would receive government insurance for a specific set of mortgage investments guaranteed by private insurers. If the private companies cannot pay, the government guarantee would go into effect
What Does This Mean for Borrowers?
Bottom line is that borrowers should understand what these possible future changes could mean. The possibility of removing a 70 year-old mortgage system such as Freddie Mac and Fannie Mae may make borrowers feel a little skittish.
Broken down, each mortgage option has elements that provide both advantages and drawbacks:
- Obama’s first option suggests that government would play no or a limited role in the mortgage marketplace. Advantages of this plan would be that the taxpayer would have no exposure to the market; housing bubbles would be less extreme since there would be no government interest. Additionally, since loss would hit the private sector harder, overinvestment would be minimized.
Drawbacks to the initial plan include the decline or elimination of the fixed 30-year mortgage product and rising mortgage rates. Home levels may decline and if the country experiences another recession mortgage financing may be tough to obtain.
- The second option allows for the government to step in if the market goes into crisis mode. Although government backing would be available in times of crisis, premium costs will be so high so that competition will be flat. This plan would be important during economic turmoil when diminished private support disappears. This plan provides similar pros and cons for the borrower as the first plan, however the government back program would provide protection should the market depress.
- The final option provides for government insurance to private mortgage brokers. Although the mortgage broker, banks and investors would be initially impacted should the housing market depreciate, the loss would be covered by a government insurance fund.
Some obvious benefits include an availability of the fixed 30-year mortgage, a smaller rise in mortgage rates than in the other scenarios and a smaller decline in homeownership values.
In terms of drawbacks, some of the recent symptoms of mortgage market downturn could continue to prevail such as overinvestment in real estate and Fannie and Freddie losses if the government doesn’t charge enough to cover reinsurance.
Obama’s proposal takes borrowers from their comfort zone, but a change must be made in order for the mortgage market to heal and recover. Borrowers may identify more with one option versus another, however these offers are simply “jumping off” points that will certainly be analyzed, debated and shaped to conform to benefit the majority of Americans.