Arguably the most glaring hole in Congress' financial reform is its utter failure to impose any changes for Fannie Mae and Freddie Mac. Some amendments were offered to tackle the government-sponsored entities, but all were voted down. So the question remains open: what should be done with these troubled firms? One proposal comes from Georgetown Professors Donald B. Marron and Phillip L. Swagel via a piece at economics21.org. The idea is interesting, as it intends to create a way for the government to promote home ownership without taxpayers paying the price. Unfortunately, that's not possible.
The Key Premise
First, in order to proceed you have to accept the premise that the government should be involved in promoting mortgages. While that assertion isn't at all obvious, refuting it would be a task for another time. Marron and Swagel attempt to create a more stable mortgage market where the government is still there to ensure mortgage availability.
Their plan is most clearly summed up by the great diagrams they provide. So let's start there and then work out the details. Here's how they explain how conforming mortgage market worked traditionally:
In the diagram, banks and other lenders provide mortgages to borrowers. Fannie and Freddie then purchases or insures them. Some get securitized into mortgage-backed securities (MBS), while the mortgages the GSEs keep are backed by agency debt. So investors ultimately provide the cash to fund these mortgages in either case.