The Fannie-Freddie waiting game

NEW YORK (Fortune) -- Putting Fannie Mae's and Freddie Mac's houses in order will have to wait.

A year and a half after Treasury took over Fannie Mae (FNM, Fortune 500) and its smaller brother Freddie Mac (FRE, Fortune 500), Washington is just now prepping for a debate over their future. The discussion, relegated to the back burner by Congress' struggles to overhaul bank regulation, could stretch into next year and beyond before anything is decided.

"The soonest we might see some action is mid to late 2011," said Karen Petrou, managing partner at Washington-based financial industry consultant Federal Financial Analytics. "The first priority had to be restoring financial stability, so it's not surprising it is taking a while."

The waiting won't sit well with the companies' many critics. Treasury's takeover of Fannie and Freddie is shaping up as the costliest bailout of all, as mounting loan losses and securities markdowns have forced the companies to draw tens of billions of dollars of taxpayer support.

With the firms owning or guaranteeing trillions of dollars worth of mortgages, there's a risk that the tab will mushroom, particularly if the economy stalls again over the next year.

But it is much easier to revile the firms than to fix them. Stabilizing the housing market has been the focus of the federal response to the economic meltdown, and there is little incentive to tinker now with the companies that are the main source of mortgage funds supporting a fragile economic rebound.

"There is nothing forcing the issue right now," said Paul Miller, an analyst at FBR Capital Markets. "It could be years before they figure it all out."

The House Financial Services Committee scheduled a hearing March 23 "to begin the process of considering the future of housing finance," Chairman Barney Frank's office said this week. Frank has invited Treasury Secretary Tim Geithner to appear.

The event could give Geithner an opportunity to outline the administration's view on how to reshape the giant mortgage companies. His office hasn't said whether he'll testify.

Geithner told Congress last month that the White House would announce "principles and broad objectives" for housing reform this year and aim to produce legislation in 2011. The administration had earlier said it would comment on housing reform in last month's budget proposal.

Geithner said administration officials "want to make sure that we get it right," though Rep. Darrell Issa, R-Calif., accused the White House of "punting."

Even before their bailout, Fannie and Freddie were magnets for controversy, because of the conflict between their shareholder-owners and their congressional charter to support housing.

The bailout temporarily resolved that tension in favor of support for housing, though at the cost of putting taxpayers on the hook for the giant tab attached to muddling through the housing bust.

As unpopular as the takeover was, it did succeed in buying some time. Extensive government support for the companies and the mortgage market has kept interest rates low -- making houses more affordable, containing the damage from the housing bust and helping to restore the health of big banks. Freddie Mac said this week the 30-year mortgage commitment rate fell below 5%.

But the Federal Reserve is scheduled to stop buying mortgages this month, and economists expect rates to rise over the balance of 2010, which could push house prices lower again.

Analysts at Standard & Poor's say they believe the dividends the companies pay Treasury on the aid they receive aren't sustainable. Fannie is due to pay at least $7.6 billion this year and Freddie $5 billion -- at a time when both companies expect to continue to lose money.

A cash crunch could force the government to ease the terms, as it did with other bailout recipients such as AIG (AIG, Fortune 500) and GMAC.

And Frank, who said in January he thought the companies should be abolished without explaining exactly what he meant, introduced a new bit of uncertainty Friday when he told the Washington Post the government must keep open the option of making the companies' creditors share in their losses.

None of those events would enhance the companies' low level of popularity with lawmakers and the public, which gets an airing every time the companies ask Treasury for more money after another quarter in the red.

"There has always been a high degree of political risk with these companies," said Barry Zigas, a former Fannie Mae executive who is director of housing policy for the Consumer Federation of America. "There are certainly some possible irritants now."

Yet as unpopular as the companies are, it's still not clear what might replace them. Some plans call for full nationalization, others for turning the companies into public utilities, still others for splitting them into pieces, a la AT&T and the Baby Bells. With banks still unwilling to lend and investors still risk averse, even longtime critics concede change could be years away.

"For Fannie and Freddie to be eliminated, a new mortgage-financing system must take their place, but there is not even a hint of a replacement on the horizon," Peter Wallison of the American Enterprise Institute wrote in January.

But perhaps that's the good news. Congress has spent much of the past year dealing with banking reform at a time when the press is rife with stories about overpaid bankers and the heads-I-win, tails-you-lose culture of Wall Street.

Yet the banks appear to have largely defeated efforts to rein in derivatives trading and create a standalone consumer financial products overseer.

"You look at all the work they have to do on regulatory reform, and you wonder how anyone can say fixing Fannie and Freddie is urgent," said Zigas. "What's the big rush?"