What’s Going To Happen To Fannie And Freddie?

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Mortgage-industry industry leaders will attend a summit with government officials today (Tuesday) to discuss how to reform Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB), the two mortgage giants that so far have devoured close to $150 billion in taxpayer bailout funds.

However, that meeting is likely to be derailed by a far greater problem: After making modest progress, the housing market again appears on the verge of collapse.

“There’s been a feeling in government, which seems to be more pervasive than it was six months ago, that says, ‘We’ve solved this housing problem; let’s move on to Fannie and Freddie,’” Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP in New York told The Wall Street Journal. “But you haven’t solved this housing problem. We have another round of home prices going down a little more.”

A year after the Obama administration unveiled its housing rescue program, foreclosures continue to hit new records. More than 2.8 million properties were foreclosed on in 2009 – up 21% from 2008 and up more than 120% from 2007, according to RealtyTrac.

Another 14 million homes are underwater and 2.3 million homes have less than 5% equity.

Mortgage rates are still at record lows, but home sales have plunged in the months following the expiration of the first-time homebuyer tax credit in April. Home sales in July dropped 27% in Denver, 42% in Minneapolis and 45% in Milwaukee from a year earlier, according to data from local real-estate brokers’ groups compiled by The Journal.

Meanwhile, the government’s HAMP program to modify mortgages, which has held potential foreclosures off the market, has fallen short of its goals.

In June, the number of homeowners who had government loan modifications canceled because they didn’t make their payments or couldn’t provide qualifying documents, was double that of borrowers who entered the program. Real estate professionals fear a “shadow supply” of delinquent loans and foreclosures could hit the market, causing home prices to tumble further.

The Federal Reserve said last week that it was downgrading its U.S. economic outlook and pledged to provide additional support for the recovery.

The federal government in September 2008 placed Fannie and Freddie in conservatorship and has said it will commit unlimited amounts of taxpayer money to keep the firms solvent. It has injected $148 billion so far, and that bill could go higher if prices fall further.

Even though the administration promised to produce a plan providing “fundamental change” by January, the fragile state of the housing market makes any moves to dramatically overhaul the mortgage industry unlikely.

Above all, any overhaul plan will seek to avoid rattling the $5 trillion bond market for government-backed mortgages because of the market’s heavy dependence on Fannie and Freddie. The two companies, together with the Federal Housing Administration, are responsible for nine out of every 10 new loans.

“People who have big reform ideas and objectives and no way to get there, that’s not realistic,” an administration official told The Journal.

The conference will give government officials a chance to test their ideas on industry heavyweights, including Wells Fargo & Co. (NYSE:WFC) Home Mortgage Co-President Michael Heid, Bank of America Corp. (NYSE:BAC) Home Loans President Barbara Desoer.

Bill Gross, co-founder of bond-trading firm Pacific Investment Management Co., and Lewis Ranieri, the former Salomon Brothers trader who developed the model for the private mortgage-backed securities (MBS) market that was behind a rapid expansion of credit for U.S. homeowners, are also on the list of panelists, according to Reuters.

One theory says the two companies could be turned into wholly owned government agencies that buy and hold pools of MBS. But analysts say that’s highly unlikely because it would dramatically increase the government’s role and could increase the U.S. budget deficit.

Many Republicans, who blasted the administration for not tackling the issue in the financial reform bill, want to fully privatize the firms. That also seems unlikely, since many see support for housing as the government’s obligation.

That leaves some sort of “convoluted” solution as the likely end game, Dean Baker, co-director of the Center for Economic and Policy Research told Reuters.

That’s what the banks want,” Baker said.

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