Fannie Mae And Freddie Mac Circle The Wagons

The home-loan financers' ties to the government are under siege

Franklin D. Raines, chairman of mortgage giant Fannie Mae, always figured he knew who his enemies were. For years, critics of government subsidies, housing activists, and the big banks and mortgage insurers that are his major competitors have been trying to trim Fannie's sails. Recently, with the backing of key Republican lawmakers, they have been stepping up their attacks. But now, even some of Raines's best friends are criticizing Fannie Mae, as well as its smaller cousin, Freddie Mac--the two government-chartered companies that help finance about 40% of all home mortgages in America.

Within just a few weeks, two top Clinton Administration officials fired shots across Fannie's bow. On Mar. 1, Housing & Urban Development Secretary Andrew M. Cuomo charged that Fannie and Freddie do too little to help low-income home buyers. Then, in a far more ominous move, on Mar. 23, Treasury Under Secretary Gary Gensler struck at the heart of the companies' special relationship with the federal government. Gensler endorsed legislation that would strip away key subsidies, such as their right to borrow directly from the Treasury. And he reminded investors that Fannie and Freddie bonds carry no explicit government guarantee. The response: The bonds cratered in the markets, costing Freddie, which was in the midst of selling $5 billion in bonds, about $65 million over the 10-year life of the issue.

The attacks were bad news for Raines, himself a former director of President Clinton's Office of Management & Budget and a regular on lists of possible running mates for Al Gore. While Treasury toned down Gensler's remarks within a day--insisting that he was simply restating longstanding policy--critics are gleeful. "They've put the guarantee in play," says one bank lobbyist.

Why the criticism? Fannie and Freddie were originally chartered by Congress three decades ago to make mortgages cheaper and more accessible. They purchase home loans from mortgage lenders, package them, and resell them on Wall Street. They are called Government-Sponsored Enterprises, but are in fact investor-owned companies whose shares trade publicly.

Banks have long argued that the implied guarantee unfairly cuts Fannie's and Freddie's borrowing costs. That keeps most banks out and allows the two companies to dominate the mortgage-resale business. But the banks' real fear is that the companies will start to make their own direct loans.

Fannie and Freddie deny plans to do that, but they clearly enjoy special status. The companies benefit from a $2.25 billion line of credit with the Treasury. Banks also may hold an unlimited amount of their bonds, in contrast with sharp limits on investing in other nongovernment securities. The companies can also issue debt without registering with the Securities & Exchange Commission. "All of these things make a powerful implicit argument that the government would support the holders of these securities," says Standard & Poor's Corp. Managing Director Michael T. DeStefano.

Those benefits add up to a AAA rating and sharply reduced borrowing costs: This year, on average, 10-year Fannie debt has traded at a bare 0.72 percentage points above similar Treasury bonds. In contrast, AAA-rated bonds are about 1.10 percentage points more expensive than Treasuries. When Gensler pointed out that an explicit government guarantee does not exist, the difference between Fannie and Treasury debt widened sharply if briefly.

Why did Gensler go on the offensive? Treasury officials don't want bond investors to price the debt as though a federal guarantee is assumed; that would mean a government bailout in a market crisis is also assumed. They are especially worried because Fannie and Freddie could become the country's biggest issuers of bonds--and replace Treasuries as the credit markets' benchmark. Today, the companies have nearly $1.5 trillion in outstanding bonds, while the Treasury is paying down the $2.7 trillion national debt.

Becoming the benchmark would link most of the nation's interest rates to the fortunes of just two companies. And it would make it impossible for any future Administration to let Fannie or Freddie default. "It would make them immortal," says Peter J. Wallison, a former Treasury general counsel.

Raines argues that Fannie's advantages "do reduce our costs--and the costs for consumers." Until now, that argument has made the companies bulletproof in the Washington wars.

But fears are growing that Fannie and Freddie are getting too powerful. That's why a group of banks, mortgage insurers, and subprime lenders are massing to block the companies from expanding their businesses. They even hope to strip Fannie and Freddie of some of their lucrative benefits. To help, they have scored some heavy political muscle, including former Republican National Committee Chairman Haley R. Barbour and Tony Podesta, brother of White House Chief of Staff John Podesta. And they are making progress. In February, a key House subcommittee chairman, Representative Richard H. Baker (R-La.), introduced legislation to curb many of the companies' benefits.

Fannie and Freddie aren't taking the assault sitting down. Fannie's top ranks are filled with well-connected pols, from Raines to John Buckley, spokesman for Bob Dole's Presidential campaign. Fannie also spent an estimated $6 million on outside lobbying last year.

They'll need the muscle. The bigger they grow, the bigger a target they'll be. While critics know they can't score many points against the companies in an election year, they insist that Congress will eventually mandate a level playing field. Perhaps--but not without a battle.