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Small Banks Prepare for Housing Reform

Guaranty fees are compensation GSEs receive for assuming the credit risk on mortgage loans. The fees currently max out at 25 basis points, a small sum considering the credit risk the housing giants take on, economists argue.

Davis argues the government should raise rates so that private lenders and banks can compete and eventually take over the business.

"If you increase that guarantee fee from 25 to 50 marginal basis points, the income for Fannie and Freddie doubles," Davis said. "It is not about trying to eliminate the government, but to control its involvement, like a utility."

Even though banks are eager to pick up pieces in the mortgage market, the transition is likely to take longer than the government wants. While U.S. Treasury Secretary Timothy Geithner has asked Congress to overhaul the country's $11 trillion housing market within the next two years, Davis believes that it would take at least five to seven years for the government to gradually withdraw from the mortgage industry.

"You can't change a regime without using what you have to transition to another regime," Davis said. "Those entities have to be managed in such a way as to put capital back into the market."

--Written by Maria Woehr in New York.

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