Housing Plan Signed, But Concerns Linger

The giant housing rescue plan President Bush signed Wednesday might help stanch the bleeding in the housing market, but experts on both sides of the political divide worry that it is, at best, only an emergency step.

In addition to $300 billion in government guarantees to aid homeowners threatened by foreclosure, the administration got extraordinary new powers to backstop mortgage giants Fannie Mae and Freddie Mac after their stocks plunged earlier this month. The legislation gives both companies an open line of credit at the U.S. Treasury and allows the government to buy the companies' stock through 2009. In return, the companies get a tough new regulator.

But both firms remain weird hybrid entities whose profits are private but whose losses are public, a recipe for excessive risk-taking. The new law makes the government guarantee explicit, exposing taxpayers to losses that could dwarf the savings & loan bailouts of the 1980s that cost taxpayers $300 billion in today's dollars.

The two companies tripled in size over the last decade and now control $5.2 trillion in mortgages, nearly half the nation's $12 trillion mortgage market. Their securities are embedded in the global financial system, widely owned by banks and foreign creditors. Their collapse would have paralyzed the mortgage market and caused catastrophic bank losses and a credit meltdown.

Few denied the need to prop up the companies temporarily, but former Clinton administration Treasury Secretary Larry Summers, one of several high-level advisers who met with Democratic presidential candidate Barack Obama in Washington on Monday, warned this week that Fannie and Freddie remain "highly problematic," adding, "It is easy to sympathize with those who fear that bailouts inhibit market discipline."

The prospect of fresh financial storms worried many at that meeting. "No one feels they know for sure that there aren't other bank failures out there," UC Berkeley economist and former Clinton administration official Laura Tyson said afterward. "No one knows for sure we have seen the end to the downward cycle of home prices."

U.S. home prices continued their plunge in May, including a 23 percent drop in the Bay Area. Continued declines make banks even less willing to lend, further pressuring home prices, Tyson said, threatening even prime mortgages and credit card debt.

The new law aims to help 400,000 homeowners with new guaranteed mortgages. Yet it remains unclear how many lenders and borrowers will participate. Lenders must write down mortgages 15 percent below a home's current market value.

"Those are all wild estimates," said banking consultant Bert Ely of the numbers of homeowners who may be helped. "It may have some effect at the margin, but you're still going to have lots of homes go into foreclosure." Some lenders may choose foreclosure, and many homeowners have what are now known as "liar loans," made with no income documentation, and may not be able to afford even reduced-rate loans, along with the taxes, insurance and maintenance costs that accompany home ownership. "A lot of people will find out they're better off renting, no matter how good a deal they're cut," Ely said.

Fannie Mae and Freddie Mac pose an even bigger problem. The two companies were created, Fannie in the 1930s and Freddie in 1970 after the savings and loan debacle, to boost home ownership by increasing liquidity in the mortgage market. Their main business is insuring mortgages and repackaging them as securities. They also operate their own $1.5 trillion investment portfolios.

The implicit, and now explicit, government guarantee for their debt allowed them to borrow cheaply, squeezing out private competitors and fueling their enormous growth.