Omnious signs: after years of muscling and/or seducing, Fannie and Freddie face some challenges bigger than they ever expected

International Economy, The, Summer, 2004 by Peter J. Wallison

This brings the question back to the quality of Fannie and Freddie's financial statements. No matter how they are viewed, they do not inspire confidence. Whether or not OFHEO requires Fannie or Freddie to restate financial results for any past year, neither company's capital position is what one would expect of a triple-A rated financial institution. Fannie's capital position, in addition, is considerably weaker than Freddie's. By statute, Fannie and Freddie are required to hold only 2.5 percent capital against losses on balance sheet assets, but earlier this year the Office of Management and Budget calculated Fannie's equity--as distinct from its required capital--at 1.8 percent (the corresponding number for Freddie was 4.2 percent). Although Fannie and Freddie are hugely profitable, that profit comes from the enormous leverage they are able to obtain because of their perceived government backing. If Standard & Poor's no longer accepts the reality of this backing, both their profits and their triple-A ratings will be in jeopardy.

After many successful years of avoiding serious scrutiny, reality seems now to be finally closing in on Fannie and Freddie.

Peter J. Wallison is a resident fellow at the American Enterprise Institute. He was formerly General Counsel of the Treasury and White House counsel in the Reagan Administration.