What now for Fannie & Freddie?

With Fannie Mae and Freddie Mac now firmly under federal control, what might the future look hold for the mortgage giants? Barron's has an idea (hat tip: Brian McDonald):

FANNIE MAE AND FREDDIE MAC , THOSE two wild and crazy kids who partied on Uncle Sam's dime, finally have been sent to the "time out" corner. In the near term, the federal bailout of the heretofore quasi-governmental mortgage giants, which occurred last week amid doubts about their continued solvency, will improve conditions in the secondary mortgage market, and already has begun to lower mortgage rates.

Longer-term, some in government and the financial markets think Fan and Fred should remain under federal control, while others favor privatization or the outright elimination of the agencies -- an outcome that, by some estimates, could boost mortgage rates to as high as 9%-10%. Whatever Congress decides, the seizure of Fannie (ticker: FNM) and Freddie (FRE) closes an especially ugly chapter in U.S. financial history, when greed trashed fear, and opens the door to a rethinking of mortgage finance generally, perhaps along the European model that more responsibly ties lenders to credit risk...

In the government takeover, engineered by Treasury Secretary Henry Paulson, the top managers and directors of both Fannie and Freddie have been shown the door. The Treasury has agreed to invest up to $100 billion in each of the agencies to ensure that they maintain a positive net worth on a GAAP basis...

By placing Fan and Fred in "conservatorship," not receivership, the government has created what Paulson calls a time out to recapitalize and rehabilitate the companies, not liquidate them. Both now will be under the thumb of their new regulator, the Federal Housing Finance Agency, with Treasury looking over the FHFA's shoulder...

Some proponents of continued government control argue not only that the size of their balance-sheet investment portfolios, or the mortgages on their books, should be reduced, but that the two should lose their privileged debt status, thus evening the playing field with their private competitors in the Wall Street securitization business and the mortgage-insurance game.

As for Fannie's and Freddie's shared social mission of providing cheap mortgages and extending home ownership to the less affluent, that might best be assumed by other government-owned and financed agencies, such as the Federal Housing Administration, or FHA...

Many observers, no matter their political stripe, have high hopes the U.S. will copy Europe in using "covered bonds" to finance most home mortgages. In this case, banks and other lenders retain the credit risk on home mortgages they have made, but sell bonds backed by those mortgages to outside investors, thus off-loading interest-rate risk. Such a system is cheaper and more efficient than the multi-level government-sponsored-enterprise financing system that has flourished in the U.S. for years...

THE BIGGEST POSITIVE to emerge from the Fran and Fred bailout to date is the increased amount of money that will flow into the secondary mortgage market, and at lower interest rates, to make up for the agencies' recent neglect of their mission. Under the rescue plan, the Treasury Department will create a new, unlimited borrowing line for both companies, permitting them to borrow directly from the government, using existing mortgage paper the U.S. owns to collateralize the loans.