Two Essential Fixes for Fannie, Freddie

Meanwhile, Freddie and Fannie continue to purchase first mortgages that feature piggyback second mortgages that finance the down payments.

Mortgage lenders and secondary market loan purchasers like Freddie Mac and Fannie Mae, traditionally had required borrowers to put down 20% when purchasing homes or have less than an 80% loan-to-value ratio when refinancing. That 20% provided the lenders a decent cushion in the event of falling home values. Freddie and Fannie required borrowers who didn't make 20% down payments to purchase private mortgage insurance to cover the lender in the event the loan went sour and the foreclosed property had dropped in value.

During the real estate boom, lenders started offering piggyback second mortgages to finance down payments and avoid private mortgage insurance. Then Fannie and Freddie began purchasing some of these first mortgages, even though they violated the government-sponsored mortgage-buyers' original down payment requirements.

So why keep buying them now?

"There's only one element that's going to stabilize housing, and that's buyers," says Jim LeBaron, senior director of international business advisory firm BBK. "We'll need to remain flexible."

So, in keeping with their mission to support housing, the GSEs are continuing to buy first mortgages with piggyback second mortgages. Freddie and Fannie can still securitize a first mortgage with a loan-to-value ratio of 80% or less, and can mitigate their risk by tweaking the down payment requirements a bit.

For example, there may be a combined loan-to-value ratio of 90%. So a home is purchased with a down payment of 10%, a piggyback second finances 10% and Freddie or Fannie purchases the 80% loan-to-value first mortgage, which can be securitized.