Taming Financial Lions

Better reform for Fannie-Freddie mortgage giants

It's a good example of when privileges originally bestowed to help the underprivileged have long since been stretched too far.

The case in point are two giant financial institutions, Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Mortgage Corp.). They were created by the federal government to make home mortgages more affordable to low-income American families. By any measure, they've done a remarkable job.

Fannie Mae and Freddie Mac have been available to people in good times and bad. Their roots go back to the Depression. Today, the US arguably has one of the best mortgage banking systems in the world; some 67 percent of American families now enjoy the benefits of home ownership.

Yet a growing number of critics, even within the US Treasury Department, say the two are now too big, too powerful, and have lost sight of their original purpose. Most of all, they pose a hazard to taxpayers if they need a federal bailout.

These enterprises are in the top 75 of the Fortune 500 companies, with their stock traded on the New York Stock Exchange. They are run expertly and efficiently, and have enjoyed double-digit growth over the past 10 years. They provide billions in capital to mortgage companies, buy up loans that banks and other lenders make to home buyers, and convert them into "relatively" safe mortgage-backed securities popular with investors. They are beloved by Wall Street, and - here's one problem - enjoy enormous political clout.

But to feed their gigantic appetites, these lions have had to forage beyond their original territory and now compete with the private sector in ways never originally intended.

Questionable perks

A growing chorus of critics rightly argues that the two act as private companies when it's convenient, and use the special government privileges bestowed on them when it's not. As government sponsored enterprises, they don't have to register their debt or securities with the Securities and Exchange Commission (they saved $280 million in fees in 1999). They don't have to pay state and local taxes (a $690 million savings last year.)

Banks, fearing further Fannie and Freddie expansion into the primary mortgage market, naturally question the mission of these competitors.

One relatively new aspect of their competitive advantage is that financial markets think they are too big to fail, and that the US government (read taxpayers) will bail them out in a crisis. It's not written in stone, but certainly implied.

This "implicit" guarantee is what makes change so difficult. The debt issued by Fannie and Freddie is rated triple-A. Yet their notes and bonds are not actually guaranteed by the US Treasury, despite what amounts to a symbolic line of credit. While a major recession looks unlikely, taxpayers should rightly worry about projections by leading financial institutions that Fannie and Freddie's debt could soon outpace the national debt and reach $8 trillion by 2010.

Moving toward reform

Just last week, the two institutions agreed to a few reforms, under pressure from their lead critic, Rep. Richard Baker (R) of Louisiana. The reforms provide for more monitoring and public disclosure of financial operations - although they are nonbinding and do not go deep enough.

Mr. Baker's promise to reintroduce legislation next year calling for further reforms, including an independent regulator, is a move in the right direction. The public perception that Fannie and Freddie will be bailed out by the US Treasury must change. Their symbolic line of credit must be removed. Their boards should not contain political appointees. And they should scale back to serving only the most-needy low-income buyers.

What's more, the two institutions are "substantially" behind other banks and private lenders in purchasing mortgages made to African-Americans and Hispanics.

And finally, they are using scare talk to fend off reform.

"By contending now that the mere mention of reform means turbulence for national mortgage rates, and by presuming it can intimidate the very government that sponsors its activities, Fannie Mae is itself providing the strongest justification for concern over its size," states Representative Baker.

Obviously, the time has come to decide just how large these two institutions should be, what constraints should be placed on their growth, and how they should be regulated.

(c) Copyright 2000. The Christian Science Publishing Society