Fannie's and Freddie's Big Fight

With Fed Chairman Greenspan joining a lengthening list of critics, the GSEs' very survival may be on the line

By Paula Dwyer

Fannie Mae Chairman and CEO Franklin Raines has always kept a high profile in Washington. But in the past two months, Raines has been especially visible: He has pledged to double the amount of financing available to minority home buyers, unveiled a new program to build homes for older Americans, and given speeches trumpeting Fannie's role in promoting the American Dream of homeownership for millions of low-income citizens. The peripatetic agenda had friend and foe alike asking: What makes Raines Run?

The answer: He's defending Fannie against a political onslaught unlike anything it has ever seen. For years, Fannie and its smaller sibling, Freddie Mac, fended off sniping from detractors. They range from large commercial banks jealous of the two companies' dominance of the mortgage-finance business, to free-market adherents upset that the two government-sponsored entities (GSEs) have turned a congressional charter into a lucrative subsidy -- and become financial behemoths as a result.

On Feb. 24, however, the gloves came off. Federal Reserve Chairman Alan Greenspan told the Senate Banking Committee that Fannie and Freddie have grown so large -- together they own or guarantee $4 trillion in home loans, or three-fourths of all single-family-mortgages -- that they pose an unacceptable risk to the entire financial system (see BW Online, 2/25/04, "Greenspan's Fix for Fannie and Freddie"). Greg Mankiw, President's Bush's chief economic adviser, echoed Greenspan's worries in a newspaper column the same day.


  The choreographed comments suddenly made it seem possible that Congress might finally stop debating over the GSEs' oversize liabilities -- the two companies' rapidly expanding debt now totals $1.7 trillion, up from just $223 billion in 1992 -- and do something about them (see BW Online, 2/26/04, "Why Richard Baker Scares the Street"). Investors certainly sensed the risk: In two days of trading on Feb. 24 and 25, Fannie's shares dropped 4.3%, while Freddie's declined by 1.9%.

What changed? In late December, the Fed released a draft study that concluded that the GSEs' benefit to homeowners, in the form of lower mortgage rates, amounts to only about 0.07% -- even less than the anti-GSE crowd thought. The White House has grown a lot more concerned, too. Buried deep in the President's fiscal 2005 budget is a worrisome table. It shows that Fannie's equity-to-assets ratio of 1.8% is far smaller than the ratio of 10 large, private institutions. The ratio -- a common measure of how much leverage a lender has and therefore how much risk it has assumed -- is a much stronger 7.9% at Citigroup, for example.

Both GSEs also owned up to huge accounting mistakes last year, underscoring White House fears that the two companies don't have a tight enough grip on the complexity of their operations. Freddie revealed that it had understated net income by some $5 billion for the three years up to 2003. Fannie reported a $1 billion computational error, but one that affected only stockholder equity and not profits.


  A dollop of politics may also be involved in the ferocity of the attacks on Fannie and Freddie. Both GSEs have supporters on Capitol Hill, but they are mostly Democrats with large numbers of minority constituents back home. Fannie and Freddie have extensive programs, ranging from mortgage insurance to incentives for low-cost loans and low down payments, for first-time and minority home buyers, all of which help Dems portray themselves as having delivered goodies to their voters.

On Feb. 20, for example, Fannie reps attended a ceremony to open the second phase of Markham Plaza, a 305-unit, low-income apartment building in San Jose, Calif., for which Fannie put up $24.8 million in equity financing. Representative Zoe Lofgren (D-Calif.) touted the building's development in a statement.

In truth, Fannie and Freddie have always been political organizations, with their armies of lobbyists, consultants, and ex-politicos on the payroll. Now, with Greenspan weighing in against them, they may be facing the mother of all lobbying battles -- for their own survival. It took someone of Greenspan's gravitas to credibly say the GSEs could topple the entire financial system. It will take all the lobbying clout Fannie and Freddie can muster to convince Congress otherwise.

Senior Writer Dwyer covers finance issues from BusinessWeek's Washington bureau

Edited by Douglas Harbrecht

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