It is time to pull the plug on Fannie Mae and Freddie Mac. Before they failed in 2008, both had moved well beyond their original raison d'etre: Providing low-cost funds to the housing market by packaging mortgages into bond issues and selling them to investors. Their investments in their own and others' high-risk mortgage bonds failed spectacularly. The government was forced to take them over, costing taxpayers hundreds of billions of dollars.
Today, they remain under government control. They still account for more than 90 percent of the housing finance market. Because their fees for guaranteeing and packaging mortgages into bond issues are so low, the private sector is effectively frozen out.
Policymakers should be focused on fixing this dysfunctional approach to mortgage finance. Instead, the administration and its congressional allies have launched a series of generally unsuccessful efforts to enable borrowers to refinance homes that are now worth less than they owe.
With housing gradually rebounding, the need for mass refinancing programs has passed. Rising prices will enable underwater borrowers to return to building equity. Policymakers should now turn to developing a housing finance system that will stimulate housing sales.
The process of phasing out Fannie Mae and Freddie Mac can and should begin without delay. Both housing finance giants should gradually increase the cost of their services. This will enable private sector competitors to enter the market. The transition can take place without disrupting the housing market.
The specific steps necessary to eliminate both entities are:
1. Move Fannie Mae and Freddie Mac from conservatorship to formal bankruptcy. This would give the government the legal authority to close them down and replace them with a better housing finance model.
2. Repeal both entities' perpetual federal charters and replace them with three-year charters that Congress may renew for a limited number of times if necessary.
3. Separate both portfolios of mortgage investments and turn them over for gradual liquidation to a new temporary subsidiary of the Federal Housing Finance Agency patterned on the Resolution Trust Corp., which handled the assets of failed savings and loans in the 1980s and 1990s. Liquidation should proceed as the market allows, with both entities barred from making any further portfolio purchases.
4. Reduce the conforming loan limits. These limits dictate the maximum size of the mortgages that Fannie Mae and Freddie Mac are allowed to purchase and include in mortgage-backed securities. Reducing the limit will enable private sector alternatives to replace the two giants.
5. Increase the fee charged for the federal guarantee that mortgages will be repaid if they are included in bonds issued by Fannie Mae and Freddie Mac.
6. Move all low-income housing goals and subsidies to the Department of Housing and Urban Development. Congress should then determine whether each of these policies should be continued or eliminated.
7. Sell remaining parts of Fannie and Freddie to private entities. Sales would not be based on geography, and certain parts would be reserved for sale to small banks, credit unions or smaller mortgage bankers to reduce the chance of housing finance being dominated by large companies.
8. Require continuing congressional oversight to monitor these changes and the development of a modern housing finance system.
Congress needs to build a system that will enable a healthy housing industry to better meet the needs of future generations. Shrinking and ultimately eliminating Fannie Mae and Freddie Mac while enabling private-sector entities to replace them will free housing from its Depression-era financing system. It will also encourage innovations that will provide better financing options without the threat that taxpayers will have pay for another multi-hundred billion dollar bailout.
• David C. John is senior research fellow in financial institutions at the Heritage Foundation (heritage.org).