Fannie Mae. Sallie Mae. Freddie Mac. These nicknames for the Federal National Mortgage Assn., the Student Loan Marketing Assn., and the Federal Home Loan Mortgage Corp. have an appropriately friendly, homespun connotation. At no cost to the taxpayer, say their backers, these so-called government-sponsored enterprises (GSEs) make low-cost loans available for homeowners, farmers, and college students. Fannie Mae Chairman James A. Johnson says market efficiencies imposed by his company will save Americans who buy homes this year up to $14 billion.
But there is a downside to the privately run GSEs, which also include the Federal Home Loan Banks and the Farm Credit System. One issue is risk. The five major GSEs hold or guarantee $1.5 trillion in loans and securities. And all have the implied backing of Uncle Sam. That means the markets believe if a GSE got into trouble, the government would step in. While the GSEs currently are tightly regulated and well managed, that happened in the late 1980s when the Farm Credit System had to be rescued. If a GSE stumbles, taxpayers could face a large bill.
MISSION ACCOMPLISHED? A second issue is whether these enterprises need government backing. Because of the implied guarantee, they can borrow at below-market rates. That helps homeowners and other borrowers, but it also boosts the GSEs' bottom line. Last year, government backing cut borrowing costs for Freddie Mac and Fannie Mae by about $1.7 billion before taxes.
Several long-awaited government studies on severing the public ties to Fannie and Freddie are due on May 15. It is time for a serious policy debate about creating and controlling GSEs. Congress and the Administration should take a broad inventory to see which GSEs have fulfilled their mission. For those that have, all government ties should be severed. In cases where policymakers find a GSE is still needed or provides a worthwhile subsidy, there should be a method for reserving against potential losses. "There seems to be a sense that GSEs are costless," says Treasury Under Secretary John D. Hawke Jr. "But there is a significant, implicit cost to this."
Some government-sponsored enterprises would have a hard time proving they need government backing. Sallie Mae, created to improve the liquidity of student loans, has acknowledged that its mission has been accomplished. The company is even pushing for an end to its government ties. Then there's the Federal Home Loan Bank System. With the rise of the secondary market, its role of lending money to mortgage originators is less critical than it was when the system was created in 1932.
Trouble is, most GSEs don't want to give up their government backing. So as their original missions become superfluous, they often look to create new ones. Take the Federal Home Loan Banks. Representative Richard H. Baker (R-La.) has introduced a bill, supported by the banks, that would allow them to lend money to banks and thrifts using a wider variety of collateral. The goal is to funnel more money to entrepreneurs and rural borrowers. But it's not clear the private market can't serve those niches. "It's a classic instance of having outgrown one mission and looking for another," says banking consultant Karen Shaw Petrou.
GSEs also use political clout and savvy to preserve their profitable government-backed status. They lend money at below-market rates to key political constituencies such as mortgage lenders and farmers. And politicians often view the GSEs as an easy way to funnel subsidies to certain sectors without having to carve the money out of the budget.
"NO CONTROL." A method of preparing for possible future losses on these enterprises needs to be put in place as long as they have the implied backing of the U.S. government. An insurance fund similar to the one that backs the nation's banks, and more recently the Farm Credit System, could be established and funded by contributions from these GSEs. Alternatively, Edward J. Kane, a professor at Boston College, and other academics argue that the benefits these enterprises enjoy should be accounted for in the budget process, with a reserve fund set up to absorb the potential losses. "There is no control over these subsidies in the budget," Kane warns. "And lacking that control is dangerous to taxpayers."
As these financial giants continue to grow, a better accounting of the risks they pose is in order. And the government owes it to taxpayers to be prepared if disaster strikes.