Fannie, Freddie Critics Say Warnings Were Ignored

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Fannie Mae headquarters i

A view of Fannie Mae headquarters is seen on July 14, 2008, in Washington, D.C. Karen Bleier/AFP/Getty Images hide caption

toggle caption Karen Bleier/AFP/Getty Images
Fannie Mae headquarters

A view of Fannie Mae headquarters is seen on July 14, 2008, in Washington, D.C.

Karen Bleier/AFP/Getty Images

The Government Steps In

The Treasury Department unveiled a three-part rescue plan to bolster housing finance giants Fannie Mae and Freddie Mac. The plan aims to calm jittery investors while enabling the two government-chartered companies to remain public companies.

About Fannie Mae

Original Name: Federal National Mortgage Association


President and CEO: Daniel Mudd


Charter: Created by the government in 1938 to ensure a reliable supply of mortgage credit throughout the country. Fannie Mae was set up to purchase, hold or sell FHA-insured mortgage loans that had been originated by private lenders. After World War II, Fannie Mae's authority was expanded to include VA-guaranteed home mortgages. In 1968, Congress re-chartered Fannie Mae as a shareholder-owned company.


Gross Mortgage Portfolio: $736.9 billion (May 2008)


Total Mortgage-Backed Securities, Guarantees: $2.53 trillion (May 2008)


Delinquency Rate: 1.22 percent (April 2008), up from 0.62 percent (April 2007)


Source: Fannie Mae

About Freddie Mac

Original Name: Federal Home Loan Mortgage Corp.


Chairman and CEO: Richard Syron


Charter: Created by Congress in 1970 to help expand the secondary mortgage market and increasing home ownership.


Total Mortgage Portfolio: $2.19 trillion (May 2008)


Total Guaranteed Securities Issued: $1.82 trillion (May 2008)


Total Guaranteed Securities Outstanding: $1.42 trillion (May 2008)


Delinquency Rate: 0.81 percent (April 2008), up from 0.40 percent (April 2007)


Source: Freddie Mac

The crisis faced by Freddie Mac and Fannie Mae — and the government that chartered them — is not a surprise. For decades, critics have warned about the potential for an event like this. But their warnings failed to gain traction on Capitol Hill, where Freddie and Fannie wielded enormous clout.

Since his days in the Reagan administration as a Treasury and White House counsel, Peter Wallison has been worrying about the growing power of Freddie and Fannie, both in the mortgage market and on Capitol Hill.

"They have over the years been able to put themselves in a position where there was a real question whether Congress was in charge of them or they were in charge of Congress," he says.

Wallison, who is now a fellow at the American Enterprise Institute, says among the things the entities managed to do was ensure weak regulation, access to a line of credit at the Treasury and presidential appointment of their board members.

Implied Government Backing

Their special status and their government-sponsored charters left the implicit impression the government stood behind their obligations even though they are shareholder-owned companies, he says.

"In situations like this, where the government is backing private companies with private managements, the result is the socialization of the risk — that is, all the taxpayers have to take the risk," Wallison says. "But there is a privatization of the profits. All the profits go to the shareholders and the management, while the taxpayers are taking the risk."

The profits and pay were huge. Former Rep. Richard Baker, a Republican from Louisiana and a longtime critic, brought to light the pay schedule of Fannie Mae managers during controversial Capitol Hill hearings in 2004.

"I noted that, of the top 20 officials of the company, none made less than $1 million a year," Baker says. "And during the course of a 5-year period, there were bonuses, not salaries ... bonuses paid out of $245 million. This, going to an entity that was supposed to be focused on helping first-time, low-income homebuyers getting access to housing credit."

But when Baker tried to lead reforms, he says he was stymied.

"Many in the political world were very cautious about leveling criticism, because the entities had enormous political allies and were always able to squash any reform effort that might look like it would go somewhere," Baker says.

Political Clout

Freddie and Fannie did this with political donations of their own. Here's just one example of their clout: During the 2008 election cycle, Fannie Mae has given more than $900,000 to candidates and political parties; Freddie Mac has made gifts topping $475,000. They also mustered donations and political pressure from homebuilders, Wall Street firms, Realtors and others who benefited from their business, according to Baker.

This happened despite efforts from critics, including former Federal Reserve Chairman Alan Greenspan, who expressed concern about the growth in Freddie and Fannie's balance sheets. The two entities own or guarantee about $5 trillion in mortgages, nearly half the mortgages in the country.

Doug Duvall, a spokesman for Freddie Mac, says the company was simply doing what its government charter required.

"We continue to finance mortgages for low- and moderate-income families," he says. "We're out there helping prop up the market, helping keep rates stable and low. And so anyone who ... qualifies for a Freddie Mac loan is still able to receive affordable financing today."

Both Baker and Wallison say the government had no choice but to step in and rescue Fannie Mae and Freddie Mac, because their failure would have caused chaos in the financial and housing markets.

Both critics said that after the situation stabilizes, the two mortgage giants should be gradually shrunk and made totally private.

Government Steps In To Rescue Fannie, Freddie

The federal government moved in to help bolster Fannie Mae and Freddie Mac on Sunday with a Treasury Department proposal that sets the stage for a government-orchestrated rescue. In the short term, the plan enables the two quasi-governmental agencies to continue to borrow money at favorable rates in order to fund their operations.

Last week, concerns about the financial stability of Fannie Mae and Freddie Mac were at the forefront of investors' minds, and shares of both companies tumbled.

Here, a look at some of the factors behind the rescue operation launched this weekend.

What is the government proposing?

The Treasury Department disclosed a three-part plan to enable both companies to continue to play "a central role" in the nation's housing market in their "current form as shareholder-owned companies."

The department's plan would temporarily increase Fannie and Freddie's line of credit with the Treasury; give the Treasury Department the ability to purchase stock in either of the two companies — if it becomes necessary; and give the Federal Reserve a say in setting financial requirements and standards for the companies.

The department said it arrived at the plan after consultations with the Federal Reserve, the Office of Federal Housing Enterprise Oversight — the agency that regulates Fannie and Freddie — as well as the SEC, and Fannie and Freddie. Congress would have to approve any of the measures.

The Fed also said Sunday that the companies could borrow funds at a discounted rate — known as the "discount window" — from the Federal Reserve Bank of New York "should such lending prove necessary."

So does all of this amount to a bailout?

Right now, it's more of an effort to battle the markets' lack of confidence. Opening the discount window to Fannie and Freddie "instills confidence in investors, so investors will continue to fund Fannie and Freddie," says Frederick Cannon, chief equity strategist for Keefe, Bruyette & Woods. "I don't see them using the window."

Fannie and Freddie float bonds in the debt markets and use the money they raise to fund mortgages and guarantee mortgages. There has been no liquidity crisis for Fannie or Freddie, Cannon explains: "It's simply been a crisis of confidence in the equity." The actions over the weekend, he says, will enable the two companies to continue to support the mortgage market.

Why did the government choose to step in over the weekend?

The rescue effort was orchestrated to calm investors worldwide and to prevent the collapse of these two housing finance giants. Fannie and Freddie own or guarantee more than $5 trillion in mortgages — nearly half of all the mortgages issued in the United States.

The announcements on Sunday were intentionally made prior to the opening of the Asian stock markets and a Monday morning auction of $3 billion in securities by Freddie Mac.

Last week, Treasury Secretary Henry Paulson said no immediate bailout was necessary in an attempt to calm investors. The Treasury's proposal on Sunday reflects a shift in gears to assure investors that the companies have all the money they might need, and that there's no immediate danger of a collapse. It's also a means for encouraging the continued purchase of Fannie and Freddie's securities.

Both companies said on Sunday that they hold more than adequate capital. Freddie Mac also said it expected that its June 30 results will show that the firm has "a much greater surplus" above the minimum requirements.

What are the next steps?

The rescue provisions announced over the weekend will be added to a housing bill that is making its way through Congress. But Congress has to wrestle with a number of questions that regulators left unanswered. Fannie and Freddie are chartered by Congress, but they are public companies. What implications does this have for other private companies if the government bails out Fannie and Freddie? If the Treasury Department steps in and buys Fannie and Freddie stock, will those shares be of the same class as those held by institutional and indvidual investors, and will they be worth the same?

What are the implications of these proposals for taxpayers?

For years, advocates in Congress and in the private sector have been pushing for Fannie and Freddie to have a stronger, single regulator. Among those is FM Policy Focus, a group of financial services and housing organizations. Executive Director Mike House says the legislation in Congress now is "strong and adequate" for meeting this goal. The group also supports the Treasury's proposals, which it says "will prevent taxpayers from having to bear the burden on this."

House says the key thing is for "Congress to act expeditiously and get the legislation passed so that the market will get stabilized."

If I own a home or plan on purchasing a home, what does this mean for me?

The stability of the mortgage market — keeping money available for people to buy homes — is closely tied to Fannie and Freddie. That's because the companies presently fund a huge block of the nation's mortgages, and the cornerstone of their mission is to fund mortgages for low- and moderate-income buyers.

"My sense is that all the turmoil makes homeownership more difficult," both in terms of perceptions of homeownership and its value, says Bruce Gottschall, executive director of Neighborhood Housing Services, a Chicago-based nonprofit that assists low and moderate-income people with homeownership.

The tightening of the credit markets that has been building over the last couple of months impacts peoples' ability to borrow money to buy homes. "From our experience, those in the low and moderate income are hit hardest and earliest in terms of that availability of credit," he says.

With reporting by Jim Zarroli. The Associated Press contributed to this report.



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