U.S. senators are giving final touches to a proposal to liquidate the state-owned mortgage giants, Federal National Mortgage Association (OTCBB:FNMA) (Fannie Mae) and Federal Home Loan Mortgage Corp (OTCBB:FMCC) (Freddie Mac), and substitute them with a government re-insurer of mortgage securities backed by private capital.

Fannie Mae

According to Bloomberg news, the proposal is expected to be introduced during this month and is considered as the first serious bipartisan effort to shape a new housing finance system.

The proposed legislation could, at base-minimum, set-off the process for a full-debate that could subsequently go to the Congress.

Bruce Bekrowitz’s Fairholme Capital and other leading investors such as John Paulson, Richard Perry and Claren Road Asset Management have been campaigning for restructuring and privatization of the state-owned mortgage giants, instead of abolishing them. They own a sizeable $2.4 billion in the two mortgage giant’s preferred shares.

The draft bill indicated that the Washington-based Federal National Mortgage Association (OTCBB:FNMA) and McLean, Virginia-based Federal Home Loan Mortgage Corp (OTCBB:FMCC) would be liquidated within five years and the U.S. Treasury would assume responsibility for their existing mortgage guarantees.

The discussion draft of the bill indicated any proceeds from the liquidation would first go to the U.S. government as the senior preferred shareholder in each of the companies, and then to holders of junior preferred shares, followed by holders of the common shares. Thus liquidation initiatives would greatly affect the interests of the existing private players owning the mortgage giant’s preferred shares.

Fannie Mae’s Announcement last month:

Last month, the American mortgage giant Federal National Mortgage Association (OTCBB:FNMA) announced it will pay the Treasury Department $59.4 billion, after posting a record quarterly profit driven by rising home prices and declining delinquencies. The sister mortgage giant Federal Home Loan Mortgage Corp (OTCBB:FMCC) also recorded a net income of $4.6 billion and said it will pay Treasury $7 billion dividend for the quarter.

The two companies have been under U.S. conservatorship since 2008.

Though the two mortgage giants posted record profits recently, the private financiers have to measure the exposure that they have to take in case they decide to back the new privatization proposal. The proposed legislation would require the private financiers to take a first-loss position adequate to cover price declines as steep as those reported during the past century’s recessions.

According to the draft proposal, the new agency to be rechristened The Federal Mortgage Insurance Corp., would continue existing efforts to build a common securitization platform and would have the capacity to help small lenders issue securities. The new agency would also continue with the two mortgage giant’s exiting multifamily housing guarantees.