Plenty of Blame to Go Around for Fannie, Freddie - WSJ.com

Plenty of Blame to Go Around for Fannie, Freddie - WSJ.com: "Plenty of Blame to Go Around for Fannie, Freddie
How the Pair Grew
So Big, as Dangers
Mounted, Morphed
By JOHN D. MCKINNON and JAMES R. HAGERTY
July 15, 2008; Page A14

Plenty of Blame to Go Around for Fannie, Freddie
How the Pair Grew
So Big, as Dangers
Mounted, Morphed
By JOHN D. MCKINNON and JAMES R. HAGERTY
July 15, 2008; Page A14

For years, Washington officialdom enabled Fannie Mae and Freddie Mac, the congressionally chartered mortgage companies, to grow until they dominated the U.S. market.

Now lawmakers are confronting the result: a crisis of confidence in the two companies that raises questions about whether they can make it through the deep downturn that has struck the real-estate market. And nobody wants to get stuck with the blame.
[Link]

If there's one decision that is being second-guessed, it's the 1992 legislation that created the companies' regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo. In the 1992 debate, Ofheo came away with fairly weak powers, and capital requirements for the companies were set very low. (Congress is now putting the final touches on legislation creating a much stronger regulator with powers to raise their capital requirements -- a bit late, critics say.)

Lobbyists from the companies are said to have strongly influenced the 1992 legislation, particularly in the House Banking Committee, whose chairman then was Rep. Henry Gonzalez, a Texas Democrat. Critics of the companies say that Rep. Barney Frank (D., Mass.), the current chairman of the committee, also helped put forth the companies' arguments.

Mr. Frank now is widely regarded as a strong voice for tougher regulation. "I've been a supporter of their role in housing, but I've been pushing for some time to improve the regulation," he said in a telephone interview on Monday. As for the legislation in the early 1990s, he said he doesn't recall being involved in weakening it.

A spokesman for Fannie Mae declined to comment on the company's prior approach. "It's a different era [now] and there's a very different approach to our dealings with policy makers and regulators," he said.

Fannie and Freddie issue debt to the public in order to buy up home mortgages from banks. They hold some of those mortgages as investments and securitize the rest, adding a guarantee of repayment in the event homeowners default. By now, Fannie and Freddie own or guarantee about $5 trillion in mortgages, almost half of the U.S. total.
[Barney Frank]

The two companies have been so successful because they combine the private sector's appetite for profit with the government's ability to borrow money. Even officials who gave them their unique structure 40 years ago didn't entirely appreciate how powerful -- and potentially dangerous -- the combination would prove to be.

"I don't think anyone had any inkling that they were doing anything but good," says Thomas Stanton, a Washington lawyer and longtime critic of the companies' massive growth. "People hadn't really worked out what would happen."

When it comes to their dealings with Fannie and Freddie, politicians often have had self-interested motives, in addition to the lofty public purposes they proclaimed.

Congress created Fannie as a government agency during the Great Depression, to encourage banks to lend. Fannie continued to function as a government-run agency during the 1940s and 1950s, even as it took steps toward privatization.

In 1968, President Lyndon Johnson decided to turn Fannie into a shareholder-owned company as part of a broader housing bill. Mr. Johnson proclaimed that the new Fannie Mae would "close an important gap in the existing network of financial institutions." In fact, administration officials acknowledged that the move actually was aimed at shifting Fannie's growing operations off the government's books.

Investors continued to assume that Fannie's debt carried the full faith and credit of the U.S. government, however. Congress did little to dispel that idea, bestowing a range of breaks on the companies, as well as other government ties.

Fannie's model proved so effective at aiding business for mortgage bankers that the savings-and-loan industry soon wanted one of its own. So in 1970, Congress created Freddie Mac. Nowadays, both serve the same customers -- mortgage lenders.

The companies' operations suited a lot of other people, too: home builders, real-estate agents, Wall Street investment houses and politicians. And, of course, the companies have helped millions of people buy homes, particularly in times of economic uncertainty.

Critics have popped up over the years, but they were always drowned out. In the early part of this decade, Alan Greenspan became the most powerful voice calling for a reining in of the companies.

At that time, though, the main worry about Fannie and Freddie was the interest-rate risks that arise from holding long-term mortgages and funding them with borrowing. This prompted the companies to use huge amounts of derivatives to hedge. And that worried a lot of people. It also led to the accounting scandals as Fannie and Freddie tried to smooth over the fluctuations in earnings created by those interest hedges. That added to the interest in strengthening their regulation, particularly among conservatives in the Bush administration.

Few critics focused then on the credit default risks. That's because of a widespread assumption that homeowners rarely default. Now that assumption is being undermined in the current weakening real-estate market.

Fannie and Freddie's survival is crucial not just for the U.S. mortgage market, but the entire financial system, because of the widespread reliance on their debt not only by legions of investors but also by banks around the world.

The failure of one of the companies would create a "world-wide panic," says Peter Wallison, a critic of the companies' structure and operations.

Write to John D. McKinnon at john.mckinnon@wsj.com and James R. Hagerty at bob.hagerty@wsj.com