So Much Power in the Hands of So Few

Fannie and Freddie under scrutiny

February 12, 2004

By PATRICK CROWLEY

Combined, they own or guarantee 42 percent of the $7 trillion U.S. mortgage market, according to Bloomberg News, and have $1.5 trillion in outstanding debt.

Fannie alone reported nearly $900 billion in assets at the end of last year, which it manages with less than 5,000 employees (compare this to CitiGroup — with reported assets just over a trillion dollars and 275,000 employees).

They are publicly traded, yet were established by the government — the companies are known as Government Sponsored Enterprises, or GSEs — and operate under special rules not afforded to other private enterprises, including billions of dollars in tax breaks and exemptions.

And they wield power on Capitol Hill, spending millions of dollars annually promoting, wining, and dining the members of Congress who set those rules.

Yet the Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corp, or Freddie Mac, have never before been under such scrutiny as they are right now.

The White House, powerful members of Congress, and industry watch dogs are calling for tougher regulations and more oversight of the two companies — which are both based in the Washington D.C. area.

“We cannot tolerate inadequate and ineffective regulation of entities as important to the U.S. home mortgage market as Fannie Mae and Freddie Mac,” Senate Banking, Housing and Urban Affairs Committee Chairman Richard C. Shelby, R-Ala., said in a recent speech to the American Bankers Association.

Shelby says his legislative priority for this year will be a move to eliminate the companies current regulatory agency — the Office of Federal Housing Enterprise Oversight — and replace it with a stronger and more independent overseer.

“Our goal is to create an independent and expert regulator for the GSEs,” Shelby said, “and making these necessary reforms will produce regulatory credibility that will ultimately benefit the government sponsored enterprises.”

Another GSE critic, Rep. Richard Baker, R-La., chairman of the House Financial Services subcommittee on capital markets, told Bloomberg News in January that he was “optimistic before the year is out, you will see a new regulatory structure in place.”

Shelby, Baker, and others say that under the current oversight structure, there is not enough scrutiny of GSE operations, including the amount of debt the companies take on.

Critics have also pointed to accounting problems at Freddie, which has acknowledged understating its earnings by $5 billion for 2000 to 2002 to mask volatility. And in October, Fannie disclosed a $1.1 billion accounting error in its third quarter earnings report.

The Bush administration also backs stronger oversight of GSEs and wants financial oversight moved to the Treasury Department and away from the Department of Housing and Urban Development (HUD).

The argument for change was bolstered Tuesday (Feb. 10) when Congress’ top watchdog, the General Accounting Office, or GAO, issued a report calling for strengthening GSE oversight.

U.S. Comptroller David Walker, who heads the GAO, made the same argument Tuesday in testimony to the Senate Banking Committee.

“GSEs should strive to achieve model corporate governance structure,” the GAO said in a written summary of the report. “However, GSE corporate governance has not always reflected best practices.”

An example the GAO sites is the dual roles performed by the Fannie and Freddie CEOs, who also serve as chairmen of their respective boards.

The situation “is not consistent with model governance standards that call for officers to work for an independent board,” GAO said.

“Because of a lack of clear measures, it is difficult for Congress, accountability organizations, and the public to determine whether the benefits provided by GSE’s’ activities are in the public interest and outweigh their financial risks,” the agency said.

GSEs don’t make loans. Rather, they buy mortgages, bundle the mortgages together and sell them as securities. Congress chartered Fannie in 1968 and Freddie in 1970 to pump money into the mortgage industry and make home purchases available to low and moderate income buyers as well as those in urban areas.

The plan worked incredibly well. Though rivals, Freddie and the larger Fannie have grown into Fortune 500 companies and are the world’s largest buyers of home mortgages.

The last major change in GSE scrutiny came in 1992 when Congress, concerned with the rapid growth and reach of the GSEs, established the Office of Federal Housing Enterprise Oversight (OFHEO) to regulate the two companies. Even though the agency oversees two huge financial enterprises, it is not part of the Federal Reserve or Treasury. Instead it falls under HUD.

And while Fannie and Freddie are publicly traded, they do not have to follow Securities and Exchange Commission regulations on reporting certain financial information.

After the accounting problems at both companies were revealed, critics railed that more oversight is needed by the government because the government could ultimately have to pay the bill for any major mishaps.

“Although the federal government does not explicitly guarantee the GSEs’ approximately $4.4 trillion in financial obligations,” the GAP report stated, “the potential exists that the government would provide financial assistance in an emergency.”

Shelby said he does not mean to fault current regulators in the OFHEO. Nor does he want to hamper the growth of the GSEs.

“We cannot, however, ignore the events of last year,” Shelby said. “The accounting irregularities at Freddie and Fannie and the subsequent fallout from the events of last year has made one thing perfectly clear. OFHEO is not equipped to properly supervise the GSEs.”

HUD Secretary Mel Martinez told Dow Jones late last year that there has been an “underlying unease” about GSE regulation.

“There’s a tendency not to want to tinker with something that’s going well,” Martinez reportedly said. “But when something like the Freddie (accounting) problem surfaces, it does give you a notion that maybe it’s something that needs to be addressed.

“I think it’s more of a recognition that a strong regulator is a better thing for the American taxpayers and for the entities themselves and for the housing industry,” he said. “It is a good thing to do.”

Fannie and Freddie have publicly welcomed additional scrutiny. But the companies have also said they are doing a good job providing affordable housing under its current setup.

“Our charter does provide significant benefits that lower our costs and allow us to lower mortgage costs for consumers,” Fannie CEO and Chairman Franklin Raines said in a recent speech to the American Enterprise Institute.

Raines also defended the GSEs high level of debt.

“Our debt doesn’t exist in a vacuum,” he said. “Our debt funds mortgages and there’s a home behind every one of Fannie Mae’s mortgages.”

Behind the scenes, the companies work — and spend — hard to keep the status quo, spending a combined $9.7 million on lobbying in just the first half of last year, according to Political Money Line, a campaign finance group.

The companies also contributed nearly $6 million in contributions to the Democratic and Republican parties, according to a report from the Center for Responsive Politics.

“We need to ensure that, as policy makers return to the task of strengthening the financial regulation of the GSEs that they also preserve our mission, which supports the housing finance system,” Raines said in a written statement released in December, “a system that home buyers and the economy need and the world envies,” he said.

But a study last year by the Congressional Budget Office found that GSEs are no longer needed in the nation’s financial system, and that taxpayers could be at risk in the unlikely event that either company defaulted on its massive debts, The Washington Post reported.

The Post also reported that N. Gregory Manikw, chairman of the president’s Council of Economic Advisers, said that only a portion of the advantage the companies have under their federal charters actually get passed on to home buyers.

Freddie Mac Sharon McHale disputed those findings, telling the paper that the “funding advantage that accrues to us as a result of the congressional charter is passed along to consumers many times over.”

Patrick Crowley is a political reporter and columnist and former business writer for The Cincinnati Enquirer. Email Patrick at: pcrowley@enquirer.com