The Mouse Roaring at Fannie and Freddie
There's a new kid on the block, and the big boys don't like it one bit. Six years ago, Alex J. Pollock, a puckish philosophy teacher-turned-banker, launched a program to buy mortgages from banks at his little-known Federal Home Loan Bank of Chicago. The move took him far beyond his bank's brief to provide credit to small banks, thrifts, and insurers -- and put him on a collision course with Fannie Mae (FNM ) and Freddie Mac (FRE ), the titans of the mortgage business.
So far, Pollock's brainchild has not only avoided getting crushed, it has thrived. With growing numbers of banks and thrifts selling their mortgages to Pollock's Mortgage Partnership Finance program, to the chagrin of Fannie and Freddie, the value of its outstanding loans jumped 130% in just 12 months, to $68.8 billion, as of June 30. Already, that equals 8.5% of the $812.5 billion in mortgage debt that Fannie Mae owns. After beating back repeated attempts in Washington to cap or quash his program, Pollock, the chief executive of the Chicago bank since 1991, sees its growth as a sharp slap at his outsize rivals. "We are growing...three or four times faster than Fannie Mae or Freddie Mac," he says. "We are a very real alternative."
An alternative is just what many housing experts -- and key figures on Capitol Hill -- have long wanted. Fannie and Freddie have grown enormous -- helped by the country's homeownership boom, but also by government charters (which Pollock's bank also has) enabling them to borrow money at lower rates, pay fewer taxes, and escape many corporate-reporting requirements.
A long-simmering debate over whether Fannie and Freddie are too big and take on too much risk exploded in June, when a still-unfolding accounting scandal cost the jobs of Freddie Mac's three top executives. Fannie's and Freddie's toughest critics say the best long-term answer would be to level the playing field by cutting their government links, or at least put them under a tougher regulator -- not just encourage a rival to horn in on their market. But for now, House capital markets subcommittee Chairman Richard H. Baker (R-La.) says he wouldn't mind if Pollock's program grew. The home-loan-bank system (Chicago is one of 12 regional banks) "is like the teenager Fannie and Freddie," he says. "I don't see any urgency to constrain [them]."
Such high-level support alarms the program's many foes. And it's giving Pollock, who boasts master's degrees in philosophy from the University of Chicago and in international relations from Princeton University, an advanced course in political hardball. Opponents accuse him of mission creep. Gregory Baer, a former Treasury official and a lawyer who does legal work for Fannie and other critics, says Congress has never authorized home-loan banks to buy mortgages. And so, it "has never established the safety-and-soundness protections" for the program as it did for Fannie and Freddie, he says.
Fannie Mae -- famous for its deft lobbying on the Hill and its generous donations to friendly legislators -- has had Pollock's mortgage program in its sights almost from the start. In early 2000, when the program counted only $1.8 billion in assets, officials at Fannie Mae fretted that this tiny challenge posed an "immediate threat" to their business. In an in-house memo, they spelled out a bare-knuckled strategy whose "endgame" was to convince the federal home-loan banks "that our business is NOT a business in which they want to compete." Fannie aimed "to maximize our business volume at the FHLB's expense with a minimum impact on our expected business margins and fees," the memo said. As part of this effort, Fannie supported a campaign to cap the value of mortgages the Chicago bank could buy.
That campaign failed, but Fannie has never given up. For example, it funded a report released in June by Sheila C. Bair, a former Treasury official and now a professor of financial regulatory policy at the University of Massachusetts' Eugene M. Isenberg School of Management. In the report, titled Is the Federal Home Loan Bank System Forsaking Its Roots?, Bair argues that the home-loan-bank system is taking risks for which it is not prepared. And on July 21, at a Senate hearing, Fannie officials lambasted Pollock's program in a printed handout, charging that it serves mainly big banks and overstates Fannie and Freddie's importance to the housing market. They even faulted it for its exemption from federal income taxes, which Fannie and Freddie pay. All three, though, are exempt from state and local income taxes.
Even some of Pollock's colleagues are uneasy about his fast-growing program. Federal Home Loan Bank of Atlanta President and CEO Raymond R. Christman has set up a program similar to Chicago's. But he worries that Pollock's ambitions are too big for a system that started during the Depression as a sort of Federal Reserve for the thrifts and small banks that joined up as members. The main job of the home-loan banks, he says, is to provide credit to member banks; competing directly with Fannie and Freddie "overlooks what I believe is our core mission."
Pollock dismisses such arguments. He says the program has stood up to legal challenges and does exactly what the home-loan banks were organized to do. Insists Pollock: "Every dollar of the program's funding directly helps an American family finance a home."
Supporters also point to an important difference between the Chicago program and those at Fannie and Freddie: It disperses much of the mortgage risk to the hundreds of banks that participate, while its two rivals concentrate the risk with themselves. When local banks sell their loans to Pollock's program, they stay on the hook if borrowers default. To compensate lenders for keeping that credit risk, the program pays them a monthly fee. By contrast, Fannie and Freddie take the risk off the lenders for a fee. Because the Chicago program's lenders are stuck with the risk, they may be more careful. Only 0.1% of the program's loans are delinquent, vs. 0.56% for Fannie Mae and 0.8% for Freddie Mac.
For the Chicago bank, the mortgage program is a big profit center. It makes money on the interest homeowners pay on their mortgages minus the interest it pays on low-rate bonds that it sells to institutional investors and foreign banks. It can borrow at lower rates than other companies because investors believe the government will make good on the loans if the home-loan bank system faces a crunch. Last year, the program generated $196.5 million, nearly half of the bank's interest income.
But Pollock is just getting started. Under an arrangement begun in March, Chicago's Bank One Corp. is packaging the mortgages his bank buys, in much the same way as Fannie and Freddie, so that he can resell them as securities to the home-loan-bank system's members. Fannie Mae opposed this plan, bolstered by support from the Congressional Black Caucus, keen advocates for Fannie and Freddie because of their role in making housing more affordable. The Bank One deal could be construed as a first step toward selling such securities to the public, as Fannie and Freddie do -- although Pollock insists there are no plans to do so.
His program may soon get another big boost from Washington. By yearend, the home-loan-bank system's regulator, the Federal Housing Finance Board, is expected to allow the program to buy loans from member banks and thrifts that originated with nonmember financial outfits -- an ambiguous area in the rules now. Even rising interest rates could drive up business for the program, and for its rivals, as banks scramble to sell off low-rate mortgages before rates go higher. Clearly, as Pollock's program gets bigger, this fight will get nastier.
By Joseph Weber and Ann Therese Palmer in Chicago, with Amy Borrus in Washington