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The Obama Plan: Goldilocks, Fannie, Freddie and FHA

Are we heading toward a Goldilocks solution for Fannie Mae and Freddie Mac? And if so, what does that really mean for consumers and real estate professionals?

The Obama administration’s much-delayed “white paper” on housing finance reform — nearly two years in the making — turned out to be just 31 pages that essentially said: Total privatization of the home mortgage market won’t suit us. (Too hot.) Total nationalization of the market won’t, either. (Too cold.) But something in between — well, you know the story — should be just right.

Because of its diminutive size and lack of specificities, it’s easy to dismiss Obama’s report to Congress last week. But the administration’s emphasis throughout on the need to reduce the federal government’s footprint in the mortgage market was an important message to Republicans in the House and Senate: We can work with you.

We’re prepared to resist consumer groups and others who want us to simply “fix” Fannie and Freddie rather than to kill them. We can wind down both companies within as little as five years, and do a lot more between now and then to slash the size of federal programs along the way.

Fannie, Freddie plan targets jumbo limits

For real estate professionals, a transition from 90 percent federal control of the market — Fannie, Freddie, the Federal Housing Administration, Veterans Affairs, U.S. Department of Agriculture and the Federal Home Loan Banks add up to about that percentage today — down to something under a 20 percent share will be where you really want to stay focused.

Some of the interim steps could be jolting and troublesome for your immediate business, and tough on consumers who don’t have large down payments and assets who want to buy houses this year and next.

The administration’s interim strategy, in a nutshell: Make Fannie, Freddie, FHA and the others progressively less attractive to homebuyers by raising their prices, making underwriting requirements stricter, and lowering their overall availability.

Equally important: Much of what the White House has in mind for the short term can be accomplished administratively — there’ll be no need to ask Congress for permission.

What are some of the baby steps along the way that could affect home sales and financing in the months immediately ahead? Start with FHA, which has approximately a 30 percent share of the home purchase market nationally, and easily double that for first-time homebuyers who are African-American or Hispanic.

The administration wants to slash that by as much as two-thirds during the next several years, allowing the agency to revert to its “historic” average market share of 10 to 15 percent.

To get that ball rolling, FHA intends to raise its annual mortgage insurance premium by a quarter of 1 percent (25 basis points) this year. That’s on top of premium increases last year, plus an expected decrease in maximum seller contributions to 3 percent of the loan amount, down from the traditional 6 percent.

(FHA proposed that decrease last year, triggering criticism from the National Association of Realtors and other housing groups, but has not yet finalized the rule. With the White House’s new emphasis on reducing FHA’s attractiveness to consumers, don’t expect to see much compromise on the 3 percent cap, as critics have demanded.)

Next on the list: Cut FHA’s maximum loan size, starting Oct. 1, when the current statutory limit of $729,750 for high-cost areas drops back to $625,500. But the paper suggests that FHA will then explore further reductions nationwide in order to retarget the agency on lower- and moderate-income families.

Significantly lower limits — say down to or below a $417,000 ceiling — could be a deal-breaker for some homebuyers in high-cost areas of California, along the East Coast, and elsewhere if borrowers have marginal credit and small down payments.

A final step toward shrinking FHA’s market share would be to increase the current low 3.5 percent minimum down payment. “FHA will consider other options, such as lowering the maximum loan-to-value ratio for qualifying mortgages more broadly,” said the report.

How high is higher for the minimum down payment? Five percent down is the most likely — another deal-killer for many buyers — but again, the white paper offered no specifics.

The administration has a list of short-term changes for Fannie and Freddie as well, including lowering conforming loan limits as of Oct. 1 (to $625,500 and below), higher down-payment minimums (heading toward 10 percent), and higher guarantee fees for lenders.

All of these will increase costs for homebuyers and make Fannie and Freddie less significant sources of mortgage money.

Where will consumers go for financing as these changes kick in? The administration’s theory is that the private sector — primarily the big four banks — will step in and fill the void.

Really? Will they do so in the absence of a robust securitization market? Will their offerings and pricing to people who can’t make 5 or 10 percent down payments be anywhere in the ballpark compared with what homebuyers can obtain today through Fannie, Freddie or FHA?

Excuse my skepticism, but I really doubt they will.

In the meantime, Congress is starting its work on its own plans for Fannie-Freddie reform. The Obama white paper suggested three broad frameworks for Congress to consider:

1. Retention of FHA, VA and USDA as the federal government’s players in the market, but with no federal financial backups or guarantees available for lenders in the event of losses.

2. Retention of FHA, VA and USDA but creation of some unspecified federal guarantee or insurance mechanism that would “scale up” during times of economic crisis but otherwise not be a factor in a private lender-dominated marketplace.

3. Retention of FHA, VA and USDA but creation of a reinsurance entity that would cover “catastrophic” losses. This reinsurance would be the final fail-safe to prevent a total blowout. It would back up “significant private capital” and federal insurance at the mortgage securities level that would be available to regulated lenders.

That’s the shape of the future, long term and short term, at least according to the Obama administration. The long-term resolution is almost certainly years away from taking final shape. But key changes could hit much sooner, and sooner is where we all live.

Fannie and Freddie are toast for the long term. But some homebuyers probably are going to get burned in the short term.