How Fannie and Freddie let the banks off easy

NEW YORK (CNN) -- Imagine depositing your paycheck at the local bank each week only to have the bank lose your money, but never face any consequences.

That essentially is what Fannie Mae and Freddie Mac enabled banks to do. Since these two government-sponsored housing finance giants bought up the home loans that banks made, lenders were effectively let off the hook for their incompetent, unethical or simply unfortunate lending policies.

While bankers were pushing home loans during the housing boom on virtually anyone with a pulse they had a safety hatch in Fannie and Freddie. Bankers knew they could sell those mortgages - even those that were highly risky - to Fannie Mae and Freddie Mac, which would then have to worry about the bad credits.

"Allowing banks to get off the hook is one of the key problems that caused the financial crisis," argues Peter Wallison, former General Counsel at the Treasury Department and a member of the Financial Crisis Inquiry Commission. "The government should get out of supporting the mortgage market. It's been a disaster for taxpayers."

After a $134-billion taxpayer-funded bailout of Fannie Mae and Freddie Mac in 2008, the White House is now considering Wallison's advice. On Friday the Administration will propose gradually phasing out Fannie Mae and Freddie Mac, according to Administration sources.

To be sure, Fannie and Freddie will not be disappearing any time soon. Congress would have to approve the plan. And even then, the white paper from the Treasury Department and the Department of Housing and Urban Development will recommend at least three options that would keep the government involved in the mortgage market in the event that Fannie Mae and Freddie Mac are shut down.

One measure would limit Washington's role to current programs at the Federal Housing Administration and the Veterans Administration, while two others would keep the government involved in supporting the secondary mortgage market, either during times of financial stress or all the time, according to administration officials.

Advocates for federal involvement in the mortgage market argue the government-sponsored enterprises allow more Americans to achieve the dream of home ownership by increasing funds available for mortgage loans.

"Now is not the time to abandon our government's long-standing commitment to housing," said Bob Nielsen, a home builder in Reno, Nevada and Chairman of the National Association of Home Builders. "Restoring the health of the housing industry is a crucial first step in bolstering job creation and leading the economy to higher ground."

"The federal government must continue to play a role in the mortgage markets to ensure the steady flow of safe and affordable mortgage funding that middle-class consumers need, and only the government can provide that backing," said National Association of Realtors President Ron Phipps, of Phipps Realty in Warwick, R.I.

Freddie Mac declined to comment, while Fannie Mae did not respond to requests for comment.

Congress has already taken steps to stabilize the mortgage market.

Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act scheduled to take effect over the next year include: requiring banks selling mortgages to have "skin in the game" by holding on to as much as 5% of a loan they are securitizing; requiring lenders ensure a borrower's ability to repay; prohibiting unfair lending practices and establishing penalties for irresponsible lending.