Hearings Signal Bush Proposal Gaining Steam

Administration seeks Treasury oversight of Fannie, Freddie

September 19, 2003

By MARSHALL TAYLOR

In fact, the recent accounting and earnings scandal at Freddie, resulting in the ouster of back-to-back chief executive officers, Leland Brendsel and David Parseghian, as well president and chief operation officer David Glenn, were barely mentioned as a rationale for tighter financial scrutiny of the GSEs. Freddie Mac has been forced to restate its earnings over the past three years, which may have been understated by as much as $4.5 billion. Freddie officials designed trading vehicles to hide and push earnings into future quarters after the implementation of new derivatives accounting standards led to a huge earnings spike in order to maintain the illusion of “Steady Freddie” quarterly earnings growth.

But, Snow did allude to the need to take corrective action in the wake of the alleged Freddie accounting fraud when he stated that the new agency should determine that the GSEs have in place strong internal controls over their assets and liabilities and high ethical and professionals standards in their financial conduct.

Also, the administration wants Congress to eliminate the statutory requirement for presidential appointees to the boards of directors of the GSEs. Snow said GSE board appointments should go though a board nominating committee as is done at all major corporations. Freddie’s board has been accused of being asleep at the switch, when all the accounting irregularities were taking place.

“There is general recognition that the supervisory system for the housing-related government-sponsored enterprises neither has the tools, nor the stature, to deal effectively with the current size, complexity and importance of these enterprises,” Snow said.

“We should keep our eye on the crucial task of getting the regulatory organization right,” he said. The new agency in Treasury should have a clear mandate and the tools necessary to oversee the financial operations of the GSEs.

The new Treasury agency, unlike OFHEO, would be funded by the GSEs, and not subject to the political whims of congressional appropriations. Many have complained that OFHEO has been outmanned by lobbyists from Fannie and Freddie seeking to inhibit its size when seeking congressional funding and has been significantly underfunded in its 10 years of existence.

The new agency also would be able to set risk-based capital standards. “Broad authority over capital standards and the ability to change them as appropriate are of vital importance to a credible, world class financial regulator,” Snow said. Capital standards need to be flexible enough to employ the best regulatory thinking, conscious of the enterprises’ own measures of risk, adequate to ensure that the enterprises operate in a safe and sound manner, with capital and reserves sufficient to support risks that arise in their business.”

Snow said that the administration does not propose any immediate changes in the risk-based capital standards currently in effect. He unequivocally stated that the administration has not agreed to a five-year moratorium in adjusting the capital standards with the GSEs, as was stated last week in a newspaper report. The regulator would have greater authority than OFHEO to tighten capital requirements as GSE risks change.

Banking analyst Bert Ely, principal, Ely & Co., Alexandria, Va., said that new legislation would likely make GSE regulation more bank like. “There would be a correlation of GSEs meeting capital standards and prompt corrective action if they don’t,” he said. Sources say that Fannie and Freddie would oppose some of the capital requirements, such as having greater cash on hand for certain business activities, imposed by the Office of the Comptroller of the Currency, a federal banking regulatory.

In addition, the administration wants to establish a new GSE office in HUD to oversee the housing mission of Fannie and Freddie and the establishment of stiffer affordable housing goals. “It is necessary for the new regulatory legislation to enhance HUD’s authority in setting housing goals and sub goals and to give teeth to HUD’s enforcement of these goals,” Martinez said, including the imposition of civil penalties.

Democrats on the House Financial Services Committee, though generally supportive of a new single safety and soundness regulator, expressed concern that a strengthened financial regulator could harm the expansion of GSE affordable housing programs. Rep. Barney Frank, D-Mass., said that the new Treasury financial regulator would end up trumping HUD, the housing mission regulator, in discussions of affordable housing mandates. “What power would HUD have over Treasury in overseeing housing goals? Yell at them? What regulatory strength would be left for the housing mission?”

But, political observers said that the Democrats could be boxed in by the administration’s proposal, because it would actually strengthen HUD’s hand in setting higher affordable housing goals. Right now, HUD basically has not teeth to enforce its mandated goals.

Fannie and Freddie officials probably are most worried about Snow’s proposal that the new Treasury regulator would have power of approval of GSE mortgage and housing products and programs. Democrats fear that giving Treasury this power would inhibit GSE creativity in designing new products to expand homeownership among minorities, such as low or no down payment mortgages with flexible ratios.

However, both Fannie and Freddie support the thrust of the administration’s proposal, a strong, well funded, single financial regulator in the Treasury Department. Frank Raines, chairman and CEO of Fannie Mae, said Snow presented a plan that recognizes the need for stability in risk-based capital standards that were only implemented in the past year. “His approach will ensure the credibility of our regulator, its appropriate resources and powers and important stability in the capital and broader regulatory regime.”

The administration’s proposal represents a triumph for Rep. Richard Baker, R-La., who until recently had been a lone wolf in pushing for stronger regulation of the GSEs. “This has been the culmination of a 17 year project,” he said. Baker added that could pass the House this year, but it most likely will be enacted by the Senate next year. Prior to Freddie Mac’s scandal, the likelihood of congressional passage was nearly nil.

Marshall Taylor was the editor-in-chief for Real Estate Finance Today. In addition to more than twenty years in journalism, his background includes serving as a legislative assistant for U.S. Representative Jim Jeffries. Email Marshall at: Marshall_Taylor@earthlink.net