The U.S. Treasury Department has laid out a plan it says will repair "fundamental flaws" in the nation's mortgage market by reducing the role of government sponsored enterprises (GSE) like Fannie Mae and Freddie Mac.

The two agencies purchase home mortgages and convert them into assets for sale to investors. The two GSEs had to be bailed out by the government after the housing collapse and the two firms suffered huge losses on bad loans.

The plan, advanced by Treasury Secretary Tim Geithner, is designed to increase consumer protection, improve transparency for investors, improve underwriting standards, and other critical measures.  Additionally, the government says it will help make it easier for people to buy homes.

Winding down Fannie and Freddie

"This is a plan for fundamental reform; to wind down the GSEs, strengthen consumer protection, and preserve access to affordable housing for people who need it," said Geithner. "We are going to start the process of reform now, but we are going to do it responsibly and carefully so that we support the recovery and the process of repair of the housing market."

Housing and Urban Development Secretary Shaun Donovan says the plan will also make renting a home more affordable. While home prices have fallen or remained stagnant, rents have risen sharply in some parts of the country.

The Obama administration says its reform plan will wind down Fannie Mae and Freddie Mac and help bring private capital back to the market.  In the wake of the financial meltdown, private capital retreated from the housing market and has not yet returned, leaving the government to guarantee more than nine out of every 10 new mortgages. 

That assistance has been essential to stabilizing the housing market.  However, the Obama administration believes that, under normal market conditions, the private sector -- subject to stronger oversight and standards for consumer and investor protection -- should be the primary source of mortgage credit and bear the burden for losses.

Unfair advantage

The administration recommends ending unfair capital advantages that Fannie and Freddie previously enjoyed by requiring them to price their guarantees as though they were held to the same capital standards as private banks or financial institutions.  This, the government says, will help level the playing field for the private sector to take back market share. 

Although the pace of these increases will depend significantly on market conditions, the administration recommends bringing Fannie Mae and Freddie Mac to a level even with the private market over the next several years.

As for private lenders, the initial reaction was positive.

"We are gratified to see that one of the concepts they articulate closely tracks MBA's proposal, released eighteen months ago, that visualizes a workable, commonsense system driven by private capital," said Michael D. Berman, Chairman of the Mortgage Bankers Association (MBA). "We look forward to working with legislators, the administration and other stakeholders to evaluate the different proposals on restructuring the market without dramatically increasing the cost of credit."