Passing regulatory reform legislation, a grueling effort that has taken more than a year of debate, is just a warm-up for an even tougher fight over the future of Fannie Mae and Freddie Mac.
With an upcoming election and signs of a still-sluggish housing market, Democrats are in a lose-lose position, observers said. If they deliver a plan, it will draw heavy political fire and potentially disrupt the market. If they don't deliver a plan, they will be accused of ignoring a festering problem that may not be resolved unless there is action from the administration.
"It isn't going to matter what the administration proposes, the Republicans will decide they don't like it," said Lawrence White, an economics professor at New York University. "It's going to be difficult. It's going to be politicized."
Republicans have made their strategy obvious during the overall regulatory reform debate. At nearly every opportunity, House and Senate GOP members publicly criticized the bill for its failure to address the GSEs. They argued that without such a fix, the legislation was useless.
"The most egregious example of why this legislation is incomplete has to do with the absolute neglect of any serious treatment of the government-sponsored enterprises, Fannie and Freddie," Sen. Richard Shelby, R-Ala., said during debate on the bill. "The GSEs were integral players in the collapse of the housing market. It's simply a failure of will here that nothing is being done to reform the GSEs or at least cap the allowable losses."
The GOP clearly senses a winning political argument. Since the GSEs were taken into convervatorship, they have cost the government $150 billion, and the final toll is likely to be much higher.
The Democrats, meanwhile, have delayed taking action or developing any kind of plan. While the House Financial Services Committee has held hearings on the subject, the Obama administration has continued to kick the can down the road. After promising to have a plan early this year, the Treasury Department has now deferred until 2011.
With midterm elections around the corner, most analysts said GOP demands for some kind of fix will only get louder. "This is the one thing that Republicans could beat up the Democrats on," Paul Miller of FBR Capital Markets said. "Either the Republicans win one of these houses, which will put more pressure on the Treasury to do something with Fannie and Freddie, or the Democrats barely hold on and the Republicans continue to throw grenades."
Part of the reason the Obama administration has waited is that it has been hoping for the housing market to recover on its own, observers said. But with few signs of improvement, the administration is under pressure to take bolder action.
"The sooner the administration realizes the fundamentals aren't changing in the housing market, the better, because that means they are going to have to move more aggressively to take some of these interim steps, instead of waiting for the situation to resolve itself, which has been the strategy up until now," said Howard Glaser, a former Department of Housing and Urban Development official who now runs his own consulting firm.
Analysts said this message is slowly sinking in. Behind the scenes, observers say, officials have intensified efforts over the past two months, setting up an interagency working group with an objective of putting a concrete plan together in the coming year.
"The administration is definitely worried about the possibility of a double-dip recession and the adverse impact it could have for the housing market and, of course, the broader economy," said Brian Chappelle, a partner at Potomac Partners. "To minimize that risk, we need all hands on deck to support the housing market, and that includes more active GSEs."
That sentiment has also been reflected in remarks by Treasury Secretary Tim Geithner, who recently said the administration will act quickly in examining various proposals to reform Fannie and Freddie once the regulatory reform bill is completed.
Testifying before the Troubled Asset Relief Program Congressional Oversight Panel last month, Geithner told lawmakers that the administration plans to release a set of broad reforms early next year.
"We are deep into the process of examining what set of reforms should replace the current system we have in the housing finance market," he said. "Those will require fundamental changes of the GSEs, but we're not going to stop there."
But the administration runs risks with releasing any new plan. For starters, its very existence could spur more fear in the housing market. Fannie and Freddie, along with Federal Housing Administration-backed loans, account for the preponderance of housing market share with very little private securitization occurring.
Second, any plan will be unveiled in the shadow of the 2012 presidential election. Although banking issues typically are nonexistent during presidential campaigns, the fate of Fannie and Freddie was a top issue during the 2008 election cycle, and will undoubtedly return next time around.
"No administration really wants to have to deal with this issue," Glaser said. But "is the administration going to want to fool and tinker with the housing finance system as the president is preparing for re-election? That's the dilemma for them. On one hand, you have to address a long-term solution for the housing market. On the other hand there is political risk and economic risk in doing so."
Given the administration's history, observers speculate that it could again try to sideline the issue.
"They've already kicked the can down the road twice," White said. "All the choices are unpalatable. They may just decide to kick the can down the road to 2013."
That, too, would be risky.
The longer the market becomes used to Fannie and Freddie operating as arms of the government, the harder it will be for any kind of change to be enacted.
Glaser said it would be "irresponsible" to continue to let the system function as it exists today with increasing reliance on Fannie, Freddie and the Federal Housing Administration.
Still, even if the administration is able to deliver on its promise of a proposed plan by 2011, it's equally unlikely Congress will have enough time to address GSE reform.
"There is a very tight time line for coming up with what reform means, and then making progress on executing on that reform," said Brian Harris, an analyst at Moody's Investors Service. "By the fourth quarter of next year, we're into a presidential cycle, which is likely to make it challenging to enact anything after that."
Most analysts said that a comprehensive overhaul of U.S. housing policy won't take shape for at least another five years, with many predicting a 2016 time frame.
While details of the plan are still being developed, only one thing appears clear: there will be some kind of ongoing government role in the housing market.
There is a role for the federal government in "providing some form of guarantee to help make sure the broader housing finance markets are able to credit to housings in recessions and downturn," Geithner said in June.
But lawmakers, the market and the public are going to need more than that soon, observers said.
"Even if it weren't the time to act, it's certainly the time to plan," White said. " 'We can't take action now' is simply not a good excuse for avoiding laying out a plan."