The Treasury Department rolled out a plan Friday to slowly dissolve Fannie Mae and Freddie Mac, the government-sponsored programs that bought up mortgages to encourage more lending and required bailouts during the 2008 financial crisis.
Exactly how far the government's role in mortgages would be reduced was left to Congress to decide, but all three options the administration presented would create a housing finance system that relies far more on private money.
"It's clear the administration wants the private sector to take a more prominent role in the mortgage rates, and in order for that to happen, mortgage rates have to go up," said Thomas Lawler, a housing economist in Virginia.
Abolishing Fannie and Freddie would rewrite 70 years of federal housing policy, from Fannie's creation as part of the New Deal to President George W. Bush's drive for an "ownership society" in the 2000s. It would transform how homes are bought and redefine who can afford them.
Treasury Secretary Timothy Geithner said the plan would probably not happen for at least five years and would proceed "very carefully." In the meantime, he said the companies would have the cash they need to meet their existing obligations.
"We think there's very broad consensus on the Hill and in the broader private market that there needs to be a transition to a much smaller role for the government," he said.
Ever since the housing market went bust and the country fell into a financial crisis, pressure has been building for the government to do away with Fannie and Freddie and reduce taxpayer exposure to risk.
Fannie and Freddie own or guarantee about half of all mortgages in the United States. Along with other federal agencies, they played some part in almost 90 percent of new mortgages over the past year.
The two agencies buy mortgage loans from primary lenders, pool them, and sell them with a guarantee that investors will be paid even if borrowers default. The idea is to give people a chance to buy homes at affordable interest rates.
But the two nearly collapsed in 2008, after the subprime mortgage market collapsed and defaults and foreclosures piled up. So far, they have cost taxpayers almost $150 billion and could cost up to $259 billion, the FHFA says.
The first option proposed by the administration would give the government no role beyond helping poorer and middle-class borrowers through agencies like the Federal Housing Administration, which provides insurance on mortgage loans.
The second and third options would give the government a role as an insurer of mortgages, and each would prompt mortgage companies to pass along fees to borrowers.
Under one, the government would step in to guarantee private mortgages during a severe economic downturn, such as another housing slump, but would provide limited support during normal times.
The third option would be more complex. The government would insure a targeted range of mortgage investments that already are guaranteed by private insurers - serving as a "reinsurance" broker to those financing companies. In the event the private insurers couldn't pay the owners of the mortgage investments, the government insurance would pay.
The third option would leave the government with the largest role and probably have the smallest impact on mortgage rates. While lenders would have to pay fees, which would ordinarily drive rates higher, the government guarantees would also make mortgages a safer investment. That would attract more private money and hold rates down.
"Compared to the way things operated in the past, credit would be a little less easy to obtain, and the terms would be a little less attractive," said Nigel Gault, chief U.S. economist with IHS Global Insight.
This option would face sharp opposition from lawmakers. They fear that private lenders would inevitably take on too much risk if they had the government as a backstop. Democrats and consumer groups said they feared mortgage rates would soar if the housing finance system were left mainly to the private market, and that fewer people could afford traditional 30-year, fixed-rate mortgages. Mortgage rates today are rising but are still some of the lowest ever recorded. The national average for a 30-year, fixed loan is about 5 percent.
The changes would be felt by nearly everyone who applies for a mortgage, from first-time homebuyers to middle-aged buyers trading up for a bigger house to older buyers scaling back to a smaller home, said Joseph Murin, a former president of Ginnie Mae, the government-owned corporation that guarantees bonds backed by home mortgages.
Gault said there is an upside to making housing a less attractive investment: People who can't afford houses would be less likely to buy them, and might rent instead. Bankers would presumably lend more carefully.
Removing those buyers from the market could cause home prices to fall, however - which would help first-time buyers but hurt those who already own homes.
By sending Congress three proposals instead of a single recommendation, the administration sidesteps a politically delicate task that the new financial overhaul law left undone.
It also put pressure on Republicans in Congress, who have blamed Fannie and Freddie for the financial crisis but have yet to offer a viable plan for reforming them. Democrats control the Senate, so any new policy would have to be approved by a split Congress.
Republicans praised the White House for at least starting a serious discussion.
Conservative Rep. Jeb Hensarling, R-Texas, criticized the report for lacking detail but said it moved the debate "from if to when and how we wind down any taxpayer commitments to Fannie and Freddie." Hensarling had pushed legislation last year to sharply reduce the government's role in the housing market.
"If the White House is truly signaling they are ready to do something, it could probably happen in a matter of months," he said in an interview.
The administration can take some steps immediately without Congress' approval. It could require bigger down payments for loans that get federal guarantees, bar Fannie and Freddie from buying mortgages that are too big, or increase the fees they charge.
Those steps would make a government-backed mortgage more expensive and draw more private money into the market.
"When the administration stops talking task forces and begins to flesh this out, you'll see significant private capital injected into the mortgage market," said Karen Shaw Petrou, who advises banks on government policy for Federal Financial Analytics.
Associated Press Writer Alan Fram contributed to this report.