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Protecting Fannie's Franchise

The GOP's election gains will only turn up the heat on Raines's money machine. Incoming Senate Banking Committee Chairman Richard C. Shelby (R-Ala.) is more likely to go along with efforts to reform Fannie than his predecessor, Paul S. Sarbanes (D-Md.), ever was. And Baker is still on the war path. "Whereas Democrats want Fannie to expand their activities, Republicans want them to limit their risk," says Andy Laperriere, a Washington-based managing director of ISI Group. Since the election, Fannie's stock price has dropped 7%, to about $63.

Even before November, though, Wall Street was worried about Fannie's ability to manage its risk. Opponents say the company discloses very little about the derivatives it uses to hedge against gyrating interest rates. They want to know more--like who its counterparties are, and the extent to which Fannie is hedged. "Nobody knows how much hedging they're doing and whether their derivatives will be effective," says Peter J. Wallison, a resident fellow at the American Enterprise Institute think tank. Federal Reserve Chairman Alan Greenspan raised the issue this spring, warning that firms selling derivatives to Fannie may take on too much risk because of the perception that it has government backing. Raines counters: "Our counterparties apply very rigorous controls. If we run up against their risk limit, they don't do more business with us."

Investors became alarmed last September when they saw a sharp widening of the most-watched index of Fannie's interest-rate risk--the "duration gap" between the expected lifetimes of its mortgage assets and its debt liabilities. Fed by a wave of mortgage refinancings, as homeowners snapped up lower rates, the gap swelled to the point where Fannie's assets would mature 14 months before it paid off its debt. That was the widest ever.

But since then, Raines has shrunk the gap, to six months, by buying mortgages. That lowered Fannie's prepayment risk, since new mortgages carry lower rates and are less likely to be refinanced right away. Raines says that's a perfect example of why he's not worried about Fannie's exposure or the risk it could pose for the major institutions that hold its shares, including many mutual funds. "What is the cure? We buy mortgages. Then we're back in the comfort zone." But if the housing market comes back to earth, won't he have fewer mortgages to buy--and less room to maneuver? Raines is dismissive: "Between population growth, immigration, baby boomers hitting their peak homeownership years, [and] house price increases, our market is going to double over the next 10 years."

Indeed, the smart money in Washington and on Wall Street says that Fannie will once again survive with only a few nicks in its hide. How does Raines do it? He starts with a golden Rolodex, stocked with the names of former colleagues from his old Wall Street firm, Lazard Fr?res, and two years as budget director in the Clinton Administration. Since becoming CEO in 1999, he has hired plugged-in members of both parties--top staff from Congress and the executive branch--to enhance Fannie's political influence. That includes Arne Christenson, chief of staff to former House Speaker Newt Gingrich (R-Ga.) and now Fannie's senior vice-president for regulatory policy.

Raines also knows when to bend. When Fannie was accused this summer of being too secretive, he volunteered to give up one of its statutory exemptions and register its common stock with the SEC. By law, Fannie wasn't required to do so because of its public mission of providing liquidity to the mortgage market. He knew Fannie's refusal to file quarterly SEC reports would not sit well with the Bush Administration.

Still, the move was only a tactical retreat. Raines persuaded the SEC not to force Fannie to register its mortgage-backed securities, as other issuers must do. This deprives buyers of such crucial information as where mortgaged properties are located and the creditworthiness of the home buyers. Raines argued that the number of securities Fannie issues--40,000 mortgage-backed securities in 2001 alone--would overload the SEC and hurt liquidity in the mortgage market. He may face renewed pressure in early 2003, when the SEC and the Treasury Dept. will release a study expected to suggest ways to improve the firm's disclosure.

That Fannie Mae still retains the privileges conferred upon it in the 1930s enrages bank competitors, who three years ago formed a watchdog group, FM Watch. "Their whole premise is, `We're the American Dream Company.' Well, dream on," says Edwin S. Rothschild, an FM Watch consultant. "They're much more concerned about their bottom line." Raines counters by working closely with local nonprofits and lawmakers to encourage lenders to loan to minorities. Fannie then agrees to buy the loans. In fact, Raines recently made a commitment to invest $700 billion through 2009 to provide financing to 4.6 million minority households.

Interwoven with the Fannie legend is the personal story of Raines. He grew up in Seattle, one of seven children born to parents who didn't finish high school. His father, Delno, a city custodian, dug the foundation for his family's house by hand, paid the state $1,000 for a house that was about to be torn down, and used the lumber to build a new home. Over five years, he put in the drywall and the wiring. When he died, he and Raines's mother left $300,000, a hefty sum since neither made more than $15,000 a year. "It's a dramatic demonstration of how important access to capital and homeownership are in the lives of working-class people," Raines says.

Critics say that, for all the good it does, Fannie is leveraging its privileged status to mint money at the expense of the private sector. The company's real expertise? "They are, without question, the most effective managers of political risk in America," says Baker. Which is exactly the effect Raines hopes to have on the new Congress, too.

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