If Congress decided to wind down Fannie Mae and Freddie Mac and move toward a fully private secondary market, the Federal Housing Administration could act as backstop to ensure access to credit, according to a Congressional Budget Office report.
"In times of severe distress, the government could step in to promote liquidity," the CBO report says. "For instance, it could make FHA guarantees available to more borrowers, or it could buy MBS (as the Treasury and Federal Reserve did during the financial crisis).
The CBO researchers also warn that "full privatization" runs the "risk that it might not prove to be credible."
Investors might assume that any private firms that become "critical" to the functioning of the mortgage market could count on government support if needed.
"Investors might again treat them as implicitly guaranteed by government, weakening market discipline, reducing transparency and creating moral hazard," CBO says.
The CBO report also examines the strengths and weaknesses of using hybrid public/private entities to maintain a secondary market or a single federal agency.
CBO does not take a position on which approach the lawmakers should take as they consider the future of Fannie and Freddie in 2011.
However, CBO points out that "all developed countries with high rates of home ownership depend on some degree of government support to maintain a flow of credit to the mortgage markets during periods of financial stress."
