The apartment-lending units of Fannie Mae and Freddie Mac were among their few money makers after the U.S. housing collapse. Now they should help transform the U.S. mortgage industry.

Lawmakers seeking to eliminate the two government lenders, which were seized by regulators during the 2008 credit crisis, see an antidote to the reckless lending that blew up the U.S. housing market in the structure of the firms' multifamily operations, which share risks with lenders.

Senate Banking Committee Chairman Tim Johnson and Republican Mike Crapo are proposing legislation to create a new government-backed reinsurer of mortgage bonds that would require private investors to bear losses on the first 10 percent of capital. The model for the provision mirrors Fannie Mae and Freddie Mac's multifamily lending operations, requiring lenders to shoulder some of the risk on loans they originate.

"That sets them apart dramatically," Lisa Pendergast, a mortgage debt analyst at Jefferies Group Inc. in Stamford, Conn., said of the firms' multifamily operations. The idea is, "if it's not broke, let's not fix it," she said.

Fannie Mae and Freddie Mac's residential mortgage business collapsed because lenders sold the debt and had little at stake in their performance so they made increasingly risky loans. When the boom in subprime lending became a bust with soaring defaults, it triggered more than $2 trillion in losses at financial institutions worldwide and led to a $187.5 billion taxpayer bailout of Fannie Mae and Freddie Mac.

Unlike the firm's residential units, the divisions that lend to apartment landlords came out of the financial crisis relatively unscathed, partly because of better underwriting.

The government-owned mortgage firms' success in that segment of the market provides a glimpse of how the system could work in the larger business of insuring single-family home mortgages.

The multifamily lending model works "because the lender, in one way or another, explicitly is on the hook for losses," said Andrew Jakabovics, senior director of policy development at Enterprise Community Partners, a nonprofit affordable housing investment company. "There is a lot more due diligence that goes into those deals."

The Johnson-Crapo bill creates a new lender, the Federal Mortgage Insurance Corp., which would begin operations within five years. Fannie Mae and Freddie Mac would be wound down over that period, which would be extended if necessary to prevent market disruptions or spikes in borrowing costs, according to details released on March 17.

While the residential sides of the companies' businesses dwarf their multifamily counterparts, Fannie Mae and Freddie Mac are dominant in financing apartment acquisitions.

When banks and other lenders retreated amid the recession, Fannie Mae and Freddie Mac accounted for 85 percent of multifamily mortgages originated by financial institutions in 2009, according to the Mortgage Bankers Association.

Fannie Mae and Freddie Mac, operating with government support, supplied a steady stream of cheap cash to apartment owners through the economic downturn.

"The market didn't miss a beat in terms of capital availability for multifamily," David Brickman, the head of multifamily operations at Freddie Mac, said in a telephone interview. "The government guarantee is ultimately what made it possible."

The abundant funding was part of what enabled prices on multifamily buildings to recover faster than other types of commercial properties, though gains have slowed.

Values for apartment buildings are 6.4 percent above their pre-crisis peak through January, according to the Moody's/RCA Commercial Property Price Index. Values for all types of commercial real estate are 11.9 below peak levels.

The firms' share of the market has shrunk as other lenders return. Fannie Mae and Freddie Mac accounted for 38%, or $47 billion, of the multifamily mortgages originated by financial institutions in 2013, according to the Mortgage Bankers Association.

Fannie Mae and Freddie Mac were established to boost homeownership by making mortgages more available for low- and moderate-income borrowers. Fannie Mae was formed in 1938 in response to the crash in real estate values during the Great Depression, while Freddie Mac was created in 1970 to expand the secondary mortgage market.

The two government-run entities were seized and taken into U.S. conservatorship in 2008. By the end of this month, they will have sent $202.9 billion back to the Treasury as dividends.

The multifamily segments of the firms' business, which finance apartment buildings across the U.S., also were hurt by the economic downturn, though losses were smaller.

In 2011, Freddie Mac recorded a profit of $1.3 billion profit on its multifamily holdings while losing $10 billion on its single-family portfolio. That same year, Fannie Mae earned $644 million from its apartment business while losing $24 billion on its single-family loans.

More stringent underwriting and cheap funding weren't the only conditions that saved the multifamily divisions. Values of apartment properties held up better than those for other types of commercial properties. Falling home values and foreclosures increased demand for rentals, improving occupancies and supporting rents, according to Willy Walker, chief executive officer of Walker & Dunlop Inc. The Bethesda, Md.-based firm is the top lender in Fannie Mae's multifamily program.

Fannie Mae and Freddie Mac's presence in the multifamily business, defined as rental housing with at least five units, grew steadily starting in 1994, according to a September 2012 study from the Government Accountability Office. Multifamily mortgages from Fannie Mae and Freddie Mac range from $150,000 to $500 million.

The companies finance a wide range of properties. A November bond offering from Freddie Mac included a $31 million mortgage on Westdale Hills, an apartment complex in Euless, Texas situated on a golf course. The deal also included $246 million in debt for an assisted living facility in Fresno, Calif., according to deal documents distributed to investors.

Currently there is about $908 billion in outstanding debt against multifamily buildings in the U.S., according to a February report from Fannie Mae. The government-backed companies account for 36% of the total, the report said.

Fannie Mae financed $28.8 billion in multifamily loans last year, while Freddie Mac purchased $25.9 billion of the debt.

The companies bundle their loans into securities and sell them to investors with the understanding that the U.S. Treasury stands behind the bonds. That enables them to borrow for less than they otherwise would and pass low interest rates on to homeowners and apartment landlords.

The proposed legislation calls for the risk-sharing programs currently in place in the multifamily business to continue. Firms that originate apartment loans under the Delegated Underwriting and Servicing program, known as DUS lenders, share in losses with Fannie Mae.

Freddie Mac sells the riskiest portions of its securities offerings, which equate to about 15% of a deal, to private investors.

While there haven't been significant defaults and losses in government-backed apartment deals, subsidized lending is distorting the competitive landscape, pushing lenders that can't compete with Fannie Mae and Freddie Mac's low rates to take on more risk and potentially inflating values, according to Sam Chandan, a New York-based real estate economist.

"Some segments of the multifamily market are saturated, especially in areas where banks are going head to head with agency lenders and are compelled to take on greater risk," Chandan said. "When we look at underwriting standards, we are starting to see the envelope being pushed."

Private capital could easily meet the financing needs for apartment buildings in areas such as San Francisco and New York where demand is high, Chandan said.

There are large segments of the multifamily market that are "extraordinarily competitive," said Chandan.

Still, there probably will always be a need for government financing, Walker, of Dunlop & Walker, said. Many landlords would have struggled to find financing when funding evaporated for all commercial property types in the aftermath of the financial crisis, Walker said.

"Rewind the tape to 2008," Walker said. "There is not a bank on the planet that can say they stayed in the market when things got tough."

Bloomberg News