Fear Of Fannie And Freddie

Their expansion plans are enraging some heavy hitters

In the pantheon of political power brokers, Fannie Mae and Freddie Mac rank not far from the top. That power derives from their outsize role in the $4.4 trillion mortgage market. Now, the two ambitious agencies are looking to extend their hegemony. And that has sent some of the biggest companies in the mortgage business scrambling to come up with a response.

In recent months, mortgage bankers and insurers have grown more worried that Fannie and Freddie, private companies that enjoy government subsidies, are encroaching on their turf. Traditionally, Fannie and Freddie raise money in the global capital markets and use it to buy mortgages, either as investments or for resale as securities. Now, to boost profits, Fannie and Freddie want to deepen their market penetration.

SUPERFLUOUS? For example, the two government-sponsored enterprises, or GSEs, have encouraged bankers to use GSE software for vetting mortgage applications. And they have considered insuring mortgages that they buy, a function traditionally left to others. Bankers fear that these new underwriting systems could render them superfluous--little more than brokers for the GSEs. Insurers worry that the GSEs could crowd them out of that business entirely.

These sorties are galvanizing industry heavyweights--including mortgage subsidiaries of such well-known companies as Chase Manhattan Corp. and General Electric Co. They are discussing a lobbying response to Fannie and Freddie, say executives familiar with the talks. What shape this effort will take remains uncertain. But rumblings have been heard on Wall Street. "For the first time, a coalition has been formed in Washington of financial entities that may ultimately become a counterweight to Fannie and Freddie," says Salomon Smith Barney analyst Thomas C. O'Donnell.

Grumbling about Fannie and Freddie is hardly new. Though owned by shareholders, Fannie and Freddie were created by the government and endowed by it with certain enviable rights. The GSEs are free from local taxes, for example. And they benefit from a perception that the government stands behind their debt, which lowers their cost of funds. Returns on equity at Fannie and Freddie were a huge 25% and 23% last year, respectively. Mortgage banking, meanwhile, is a tough commodity business. Lenders, who often buy loans themselves from brokers, live on razor-thin margins--usually less than 1% on the loans they sell to Fannie and Freddie. It's easy to envy the GSEs.

Concerns about Fannie and Freddie escalated last year, say industry executives. Much of the controversy sprang from disputes over who would take the risk for offering low-downpayment mortgages. By law, Fannie and Freddie can only buy mortgages with downpayments of at least 20%. Anything lower must carry other protections--which usually means extra mortgage insurance to compensate for the lower downpayment. Freddie, in particular, figured it could offer that insurance more cheaply than traditional providers. "The mortgage insurance premiums they were charging were excessive," says Leland C. Brendsel, Freddie's chairman and CEO.

So, in October, Freddie persuaded Congress to allow it to offer other forms of loan protection--traditionally outsiders' turf. The decision led to criticism--including from the Treasury Dept., which warned the move could reduce government revenues--and was reversed. But the incident outraged industry executives. "The Freddie Mac attempt was galvanizing," says Suzanne C. Hutchinson, executive vice-president of the Mortgage Insurance Cos. of America, a trade group in Washington.

At the same time, big lenders were upset that Fannie and Freddie would only buy certain low-downpayment mortgages if they were run through their automated underwriting systems--with a fee paid for each use. Big lenders resented the charges, since they operate their own automated systems. "Ours was in place before either of the two had automated underwriting," says Mark C. Oman, chairman and CEO of Norwest Mortgage Inc., a unit of Wells Fargo & Co., the nation's biggest mortgage originator. "We have invested tens of millions of dollars in technology." Freddie's and Fannie's charges were significant: A bank that makes only $200 to $800 on a $100,000 loan sold to the GSEs would pay a fee of $30 to $50.

Freddie and Fannie don't always move in lockstep. On Mar. 24, Freddie announced an alliance with Norwest. Under the deal, nearly all mortgages customarily sold by Norwest to the agencies would go to Freddie, the smaller of the two GSEs, depriving Fannie of tens of billions of dollars in potential business. In return, Norwest would be free from any requirements to run its loans through Freddie's automated underwriting software. The deal was hailed as a hopeful sign on Wall Street, and GSE and banking officials say other similar agreements are possible. "We are certainly looking to form other strategic alliances," says Brendsel. "We have had some conversations."

But disputes over the GSEs are unlikely to go away. Bankers and insurers worry that Fannie and Freddie can use their subsidies to drive them out of business. "While the GSEs dominate the secondary market for conventional loans, they shouldn't dominate the whole industry," says Luke S. Hayden, Chase Manhattan executive vice-president.

Fannie and Freddie officials say the issue should be cost. John M. Buckley, Fannie senior vice-president, says banks enjoy subsidies of their own and calls the GSE's opponents "the coalition for higher mortgage rates." He predicts banks' efforts will fail because the mortgage market will grow more efficient--thanks not only to the GSEs but also to the Internet and other technologies. "There are folks who just want to put the higher-cost toothpaste back in the tube," Buckley says. "We are relentless in our drive to lower consumer costs." Sounds like fighting words.

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