Fannie & Freddie in the Hot Seat

0 Comments | Insight on the News, May 14, 2001 | by Catherine Edwards

Created by Congress to expand home ownership, Fannie Mae and Freddie Mac face criticisms ranging from bullying banks to setting taxpayers up for a trillion-dollar bailout.

Fannie Mae and Freddie Mac are in the hot seat once again. Last year, attacks by assorted economists, Congress and concerned citizens flew like arrows across Washington at both Fannie (the Federal National Mortgage Association) and Freddie (the Federal Home Mortgage Corp.). While the secondary mortgage-market twins emerged unscathed, they once again are facing criticism with Congress drafting restrictive legislation and the Federal Election Commission (FEC) investigating their campaign contributions.

Lawmakers also are looking into allegations that Fannie and Freddie have threatened major banks with retaliation for criticizing the mortgage-market giants. Critics continue to express concern that, soon, Fannie Mae and Freddie Mac will have assumed the risk of more than half of all U.S. home mortgages, putting taxpayers on the hook for an astronomical bailout should there be a real-estate bust.

Fannie and Freddie, both government-sponsored enterprises (GSEs), were created by Congress during the Great Depression to expand home ownership by providing liquidity in the exhausted secondary-mortgage market. Calling themselves private companies with a public mission, Fannie Mae and Freddie Mac were chartered by Congress but now are authorized to sell their stock on Wall Street.

Both buy mortgages from lenders and, in return, provide the lenders with cash to make more mortgages available to potential home-owners. The companies then bundle and sell the mortgages in packages called mortgagebacked securities to investors looking for a secure and profitable place to put their cash. This provides a continual flow of liquid money for Americans seeking to buy homes. The Office of Housing and Urban Development (HUD) long was tasked with mission oversight, but in the 1990s, Congress established the Office of Federal Housing Development (OFEHO) to ensure GSE soundness and to act as a safety regulator.

"They have outlived their usefulness," says Peter Wallison, a resident fellow at the Washington-based American Enterprise Institute (AEI). "There are many private banks that would like to be in the secondary-mortgage market." Studies show the GSEs' performance in financing low-income housing -- especially in minority areas -- is worse than that of the banks, Wallison wrote in a paper for the AEI.

"Despite the fact that Fannie and Freddie receive subsidies to perform a government mission, in this case in support of low-income housing, their need for incentives to retain a high level of profitability is an obstacle to their performance," Wallison tells Insight. "Today, the secondary-mortgage market is a mature, thriving industry," echoes Tom Schatz, president of Citizens Against Government Waste. "However, Fannie and Freddie continue to operate under a congressional charter and, as such, place the American taxpayer at enormous risk."

Rep. Richard Baker, R-La., is one of the main congressional critics of the GSEs and has sounded the alarm on Capitol Hill for several years. He notes both are highly profitable with earnings in the billions. But they come by those funds much easier than other corporations. He is concerned that neither pays state or local taxes, nor are they required to register their securities with the Securities and Exchange Commission (SEC) which, if they truly were private institutions would cost billions. In addition, they have a $2.25 billion line of credit with the U.S. Treasury, which suggests to investors that the Treasury will buy up their debt obligations should the need arise. Not so.

According to recent reports, Fannie's and Freddie's combined debt is greater than $1 trillion and stands to surpass publically held Treasury debt by 2005. While Treasury securities are guaranteed by the full faith and credit of the U.S. government, GSE debt is not, although capital markets behave as if it were. Baker fears that if Fannie and Freddie encounter financial difficulty, taxpayers would foot the bill for a bailout, as they did in the mid-1980s when Congress spent billions of taxpayer dollars to bail out the Farm Credit System.

Baker is chairman of the House Banking and Financial Services subcommittee on Capital Markets, Securities and GSEs. He introduced a bill in 2000 that would have curbed the housing GSEs and consolidated their regulators into one board. "Last year I made the argument that they pose potential systemic risk to the financial system and American taxpayers," Baker says.

This year, Baker's new bill, the Secondary Mortgage Market Enterprise Regulatory Improvement Act (HR 1409), would make the Federal Reserve Board the sole regulator. The Fed would get more banklike regulatory powers and would restrict Fannie and Freddie's mission to the secondary-mortgage market only. The proposal also would require the GSEs to register their securities with the SEC like all other American companies. "There is no reason why they should not report to the SEC," says Mike House, executive director of FM Watch, a Washington-based coalition of financial-services- and housing-related trade associations that monitors GSE activities.