MBA Proposes Breakup of Fannie, Freddie

WASHINGTON (TheStreet) -- A financial lobbying group has proposed to break up Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote) into smaller firms across the country after nearly a year of silence from the industry and regulators about how the mortgage finance giants should operate in the future.

The firms would remain public-private hybrids in a plan released Wednesday by the Mortgage Bankers Association.

Fannie and Freddie have faced criticism for years for their size and government backing, with detractors saying they reaped unfair advantages for implied guarantees on debt issuance while booking huge profits because other firms simply couldn't compete on the same scale.

The companies also served a dual role: tasked by Congress with expanding homeownership to minorities and less wealthy Americans, but also tasked with mitigating risk for shareholders. Ultimately, their increasing exposure to subprime debt helped seal their fate, pushing the two firms into conservatorship nearly a year ago.

The MBA's report says the size and scope of the U.S. housing market "warrants a federal government role" for liquidity and stability. However, the new plan would have the government provide an explicit guarantee on the risk of Fannie and Freddie securities. The firms would pay premiums into a federal insurance fund that would be used in case of default.

The guarantees would cover the credit risk and liquidity of each security, rather than interest-rate risk, implying higher coverage and premium prices. Interest-rate risk would be held by the security's investor.

The plan proposes that Fannie and Freddie would initially remain as two or three entities, called mortgage credit-guarantor entities, or MCGEs. They are now referred to as government-sponsored entities, or GSEs.