The Treasury Department provided three options in its white paper Friday for a housing finance system to replace Fannie Mae and Freddie Mac. One of which is already being criticized for potentially making too big to fail even bigger. In a conference call with reporters following the release, Treasury Secretary Tim Geithner said whatever plan Congress chooses, it would take between five and seven years to implement through three stages. He pointed out that anything done drastically in the near term would only cost taxpayers more than the roughly $150 billion spent in aid to these two firms. "A dramatic amount of losses that we have seen at Fannie Mae and Freddie Mac are on legacy assets, loans on their books before going into conservatorship. The worst thing we can do is increase the cost to taxpayers by hurting the performance of those legacy loans on their books," Geithner said. "If we took a step that would shock the market, push the market into a double dip, we could see significant impacts on those legacy loans and increase cost to the taxpayer." He said the first phase of the plan should take between two and three years, which would involve the initial steps of one of the plans and put in place new rules for the private market. The second phase, Geithner said, would take another two or three years, and would be "a point of accelerating the pace of transition." The third phase would be spent implementing the new system. Private market The first option the Treasury lays out is a completely privatized system of housing finance with the government insurance limited to the Federal Housing Administration, the U.S. Department of Agriculture, and the Department of Veterans' Affairs. The strength of this option, according to the Treasury, is that it would minimize distortions in how capital is spread across different sectors and would keep investors from taking on excessive risk. But, most importantly, direct taxpayer exposure to the mortgage market would be limited to the FHA and other "narrowly-targeted government loan programs." However, while these programs would help low- to middle-income borrowers gain access to credit, mortgages would be more expensive for everyone else. A commentary from FBR Capital is critical of this option insofar as it may stifle competition for smaller mortgage finance players. "Under this option, the cost of mortgage insurance to non-FHA borrowers will likely increase more than under the other options and smaller banks could have a difficult time competing in the market," said the note. James Lockhart, vice chairman for WL Ross & Co. told Bloomberg Television Friday that he supported this path but wished for more detail. "I think the proposals are good because they lay out three options and they certainly have taken nationalization off the table, which is good," Lockhart said. "I would have hoped they would have gone a little farther toward the first option laid out a game plan for how to get there." However, the Treasury addressed concerns that this option would raise the cost of homeownership for most. "While mortgage rates are likely to rise somewhat under any responsible reform proposal, including the three outlined here, the effect could be larger under this option," the Treasury said. "In particular, it may be more difficult for many Americans to afford the traditional pre-payable, 30-year fixed-rate mortgage." The Treasury also pointed out that it would be very difficult for it to step in at a time of crisis, and if investors believed the government would do so anyway, this option would fail to eliminate the risk of moral hazard. Crisis plan In the Treasury's second option, it offers a plan similar to the one above, where the private market would dominate, and the government would be relegated to the FHA, the USDA, and the VA. However, it would also work to develop "a backstop mechanism" to ensure homeowners had access to credit during a crisis. Coming out of the crisis of 2008, Fannie, Freddie and the FHA fund nearly every mortgage in support of a crippled market. The Treasury said the new backstop would maintain a "minimal presence" when times are good but would "scale up" when things go bad. One way to do this, the Treasury said, would be to price a guarantee fee on those loans at "a sufficiently high level" so that it would only be competitive when a crisis occurred. Another approach would be to gauge its amount of insurance from small amounts during boom years and increase it during rough patches. The Treasury said in its report that this proposal would solve the government's inability to thaw a credit freeze during times of crisis. But it doesn't come without costs. "Aside from the uncertainty around how well it would be able to scale up in times of crisis, there is the same concern with the access issues that we face with the prior option," the Treasury said. "Access to credit, particularly the pre-payable, 30-year fixed-rate mortgage, would likely be more expensive under this option than under the following one." Catastrophe fund Commentators including Moody's Analytics Chief Economist Mark Zandi and the Center for American Progress supported the idea of a catastrophe fund, built by these guarantee fees. It's also a plan laid out for Congress by the Treasury. In this third option, the government would continue to leave the mortgage market to private players outside of the FHA and other programs. But, it would offer reinsurance for a the "securities of a targeted range of mortgages." One approach for this system would be to approve some private mortgage guarantor companies with capital and oversight requirements from the government. These companies would provide guarantees for mortgage-backed securities backed by loans written to strict underwriting standards. The government would then provide resinsurance on these securities, which would only be paid out to shareholders of these companies if they are "entirely wiped out." A premium would be charged to cover future claims and to repay taxpayers. The Treasury said this option would provide borrowers with the cheapest access to mortgages going forward, and would provide more competition for smaller lenders and community banks. But, it too has a downside. If this plan is put into place, the government and the taxpayer is still exposed to the market, and housing is still in danger of artificially inflated values as before. If regulators of these private companies fail as they did leading up to the crisis of 2008, a repeat of the events that took place afterward would be inevitable, the Treasury said. When to choose Rep. Barney Frank (D-Mass.) told Bloomberg Television earlier in the week that a deal would be struck between Democrats and Republicans by the end of the year. Banking analysts and even the Treasury say that installing a new system is still years out. Still, there is much that can be done now. Housing and Urban Development Secretary Shaun Donovan said in the conference call with Geithner that there are still choices to be made now, including a national mortgage servicing standard and allowing the elevated loan limits to expire on Oct. 1. Response to the white paper has been mixed with some firms applauding the proposals they agree with and others concerned over the lack of detail. Geithner said on Friday that Dodd-Frank required them to provide options and give the pro's and con's of each, which they have done. Now, he said, they will continue to confer with market participants, academics and community organizations to implement the plan. "We should not wait. We should move forward," Geithner said. Write to Jon Prior. Follow him on Twitter: @JonAPrior