The Obama administration has gained plaudits from even conservative critics by calling for the dismantling of Fannie Mae and Freddie Mac.

But a growing number of observers are arguing that one of the Treasury Department's proposed replacements is effectively the same system by another name.

Presented as option three in the administration's white paper outlining the possible future of housing finance, the government would create a reinsurance program that would guarantee mortgage-backed securities during a crisis.

But many observers said that — just like the current GSE system — it would leave the taxpayer on the hook if the mortgage market blew up again.

"It doesn't take more than three and half seconds of reading that paragraph to realize that we are talking about another version of Fannie and Freddie," said Lawrence White, an economics professor at New York University's Stern School of Business. "Those institutions sound like, smell like, feel like, another set of Fannies and Freddies."

Under this approach, a group of private mortgage companies would provide guarantees for MBS that met certain strict underwriting criteria. A government entity would then provide reinsurance to the holders of the securities, which would only be paid if shareholders were entirely wiped out. The government would charge a premium for its reinsurance that would be used to offset losses to taxpayers.

Supporters of the idea say option three is better than the current system because the government would guarantee only the MBS after the mortgage entities take losses, and would not backstop the entities' debt. In theory, the government's role would be reduced.

But many observers question whether those benefits would be realized, arguing the government would still be a big player in the mortgage market under this approach.

"It looks like option three to a certain extent is more of the same just in a different form," said Gil Schwartz, a partner in Schwartz & Ballen. "They really haven't privatized the housing finance side by using option three, because the government ultimately provides the backstop in the form of reinsurer for these private mortgage guarantor companies. Isn't that adding a complexity to this thing that doesn't get the government out of the business?"

Of the three options put forward by the administration, option three already has the most political support, with backing by the Mortgage Bankers Association and National Association of Home Builders, among others.

"If you are in the real estate industry, you like [option] three," said Ernest Patrikis, a partner at White & Case. "In effect it is taking Fannie and Freddie and sort of privatizing them, but with a government backstop."

Conservatives, meanwhile, prefer option one, which would call for the government to leave the mortgage market almost entirely, retaining only the Federal Housing Administration (FHA) to provide support for low-income households.

In the middle is option two, which would also dial down the government's role in the mortgage market, but allow it to establish a guarantee mechanism that would scale up in periods of economic distress to fill the gap in the event private capital is withdrawn.

It remains unclear which approach the administration favors, but House Financial Services Committee members are set to grill Treasury Secretary Tim Geithner on the issue at a hearing Tuesday. Some observers wonder if the Treasury likes any of its options.

"They want to reduce the government's role, but they don't want to reduce the government's role," Schwartz said. "It's hard to figure out what the direction is going to be ultimately, and what they are going to support."

Some said the Treasury sees problems with option three, fearing it is too much like the status quo.

"My read of this is the administration sort of prefers option No. 2. I think they get that the industry and consumer advocates of the world prefer option No. 3," said Mark Calabria, the director of financial regulations studies at the Cato Institute and a former top aide to Sen. Richard Shelby. "There is a bit of jockeying that if they put out option No. 1, they figure they can drag the debate to option No. 2."

But others said the administration is trying to build more support for option three.

"The paper is a superb volley to put the ball back into Congress' court in that it makes no recommendation. It seems to have a clear preference to No. 3, but it avoids being held accountable for any specific recommendation," said Steve Blumenthal, a former deputy director at the Office of Federal Housing Enterprise Oversight, and now an attorney at Williams & Jensen.

No matter which option the administration leans toward, there are more questions than answers about how each approach would work in practice. With option three, for example, it's unclear who would start up and run the private guarantee companies to backstop MBS. Also unclear is who would regulate them.

"Who is going to be the supervisor of the government insurer?" Patrikis asked. "Who will set those requirements? Are these going to be the state insurance supervisors? Or is this going to be the Office of Federal Insurance? How will it invest the premiums, or will it put everything into U.S. government securities? And then comes the question, if we really did have humongous losses again, is the government reinsurer going to pay even if it runs out of funds?"

Another challenge is the government's effectiveness in pricing risk. Even the Treasury white paper acknowledged that the government has a hard time trying to price premiums for reinsurance. Others note that the Federal Deposit Insurance Corp., which has charged banks for deposit insurance since the 1930s, still had its fund go bankrupt during the financial crisis.

"Look at the FDIC and how difficult a time they are having trying to maintain the fund at the appropriate level," Schwartz said. "This seems to me raising the similar issues about how well does the government price premium for reinsurance? Will they have enough? What happens if there is another run on these private mortgage guarantor companies and, for whatever reason, they can't make their payments on the guarantee? The government is going to have to step in obviously, and bail them out, or certainly bail out the policy holders."

But option two appears just as problematic in its approach. The Treasury has provided few details on how a government guarantee would work and how it would be scaled up in a crisis period.
Still, the administration may find it appealing as a concept because it theoretically limits the government's role in the market to just a crisis period.

"They don't want the government backing $6 trillion of liability. They don't think the government can do that. They want to minimize the government's direct support," said Brian Chapelle, a founding partner of Potomac Partners and a former official with the Department of Housing and Urban Development.

Option one, however, takes the government largely out of the market, but does not leave it a way to support the system in the event of a crisis, which could result in a dramatic credit crunch.
Calabria said the concern is the system currently is too pro-cyclical.

"They are not approaching it from the perspective necessarily how do we keep housing prices high, or how do we continue to keep the housing market going all the time," Calabria said. "Their approach is when the mortgage market hits a tough spot, you need some sort of backstop … but they are very concerned that the current system is pro-cyclical."

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