Fannie, Freddie, And Sallie: Regulate With Care

Life may never be the same for Fannie, Freddie, Sallie, and their siblings. Over the past decades, these government-chartered but shareholder-owned corporations have grown to the point where they account for 90% of debt issued by U. S. financial companies. Yet while they are beloved by investors, they've remained relatively unnoticed by government officials.

Now they're coming under growing scrutiny that could end their carefree way of life. On Apr. 30, Treasury officials and the Congressional Budget Office recommended bringing the companies, also known as government-sponsored enterprises (GSEs), under tighter supervision.

Good idea. Unlike other financial institutions, no one is questioning the health of the GSEs, which include the Federal National Mortgage Assn. (Fannie Mae), the Federal Home Loan Mortgage Corp. (Freddie Mac), the Student Loan Marketing Assn. (Sallie Mae), the Federal Home Loan Banks, and the Farm Credit System. But if dire problems developed in their portfolios, it could be a nightmare for the government, which implicitly guarantees $1 trillion in GSE paper.

HOUSE RULES. But in reining in the GSEs, the government must not overdo it. That might choke off the entrepreneurial spirit and concern for social goals that has made the GSEs succeed. These corporations have prospered by providing badly needed financing for housing, education, and agriculture. Basically, they give liquidity to these markets. Fannie and Freddie buy home mortgages from lenders and repackage them for sale to investors. Sallie does the same for student loans.

The GSEs have been outstanding performers, producing returns on equity far higher than most financial institutions. Fannie, the most profitable of the lot, earned more than 30% in 1989 and 1990. Much of that success, critics argue, is thanks to federal guarantees.

Burned by the savings-and-loan debacle, Bush Administration officials want to forestall the possibility that those guarantees could end up costing the government a lot of money. When the Farm Credit System became insolvent in 1987, the government agreed to pump in $4 billion. Now, most experts say the ultimate cost of the rescue will total half that amount. "The whole purpose here is to avoid cleaning up another financial mess," says Assistant Treasury Secretary Jerome H. Powell. So the government wants to set up house rules for its corporate offspring to make safety and soundness higher priorities than social-policy goals.

The Treasury hopes, for example, to strengthen the casual scrutiny of Fannie Mae and Freddie Mac by the Housing & Urban Development Dept. by creating a new unit of financial regulation within HUD. The unit would be kept separate from the HUD officials responsible for promoting housing.

Treasury and the CBO want to model the supervision of Fannie, Freddie, and their brethren on bank regulation, relying on financial indicators such as capital levels to measure the companies' health. They want supervisors to set capital requirements tailored to the specific risks of each entity.

If the companies fall short, regulators could take actions ranging from a request for more capital and an order to suspend dividends to the removal of directors and officers in the worst cases. Supervisors also would get broader access to the GSEs' books. Government auditors insist they don't want to micromanage. "You want to tie regulation to financial ratios so that regulators don't get into day-to-day operations," says Larry D. Harrell, an assistant director at the General Accounting Office, which will issue its report on GSEs in late May.

While GSE officials are open to improved supervision, they want to ward against overly intrusive regulation. "Regulators are not trained to make business decisions for companies," says Leland C. Brendsel, chairman of Freddie Mac. "If they put themselves in that position, they could wind up harming the institutions."

CAREFUL BALANCE. Given the recent problems in banking, those designing rules for the GSEs should be leery about how far they push the analogy with depository institutions. "There's no evidence that bank regulation is a sound model," says Freddie Mac's Brendsel.

The swing to tighter regulation of banks after a decade or more of sloppy lending has improved that industry's health. But it exacerbated the recession by drying up credit to real estate and other sectors. If zealous watchdogs impose harsh constraints on the GSEs, housing, education, and agriculture may bear the brunt.

The regulation of any financial institution is tricky. But with corporations as complex as Fannie, Freddie, or Sallie, the difficulties are magnified. The GSEs' social mandate and financial strength need to be carefully balanced. Fannie Mae could suffer if it bought too many mortgages from low-income home buyers to promote homeownership among the poor. Yet low-income borrowers could lose out if Fannie concentrated too much on the bottom line.

The GSEs have become a massive force in financial markets, and the government has a duty to taxpayers to keep them healthy. But regulators must be careful lest they lose sight of the purpose of those they supervise.