Commentary: A New Chaperone for Fannie and Freddie?

Step aside, Terminator. Playing tough guy for a change, the Office of Federal Housing Enterprise Oversight (OFHEO) forced Freddie Mac to ax new CEO Gregory J. Parseghian on Aug. 22. It was a rare display of muscle by the regulator -- and probably its last. Freddie's accounting scandal has sparked a fight over reining in the housing financier and its cousin, Fannie Mae -- and created a high-stakes battle over how far Congress can go without hurting the housing market.

The one sure casualty is OFHEO, an arm of Housing & Urban Development. Critics want to put Fannie and Freddie on a tighter leash, and even the two government-sponsored enterprises (GSEs), once opposed to a new overseer, have quietly thrown in the towel, Capitol Hill sources say. Congress is likely to create a new regulator in the Treasury Dept., which Secretary John W. Snow is expected to back when he appears before a House panel on Sept. 10.

But critics want to make sure the new regulator has teeth -- and that's what Fannie and Freddie are fighting. Their best weapon: Washington's fear that curbing them could hurt liquidity in the mortgage market, boost interest rates, and hasten a housing slowdown. No politician wants the blame for ruining the sector that, thanks to the refinancing mania, has fueled consumer spending -- the economy's one bright spot.

Snow may counsel caution. Treasury could get modest new powers, but fundamental change is off the table for now. The GSEs' rivals, who would like to see them saddled with higher capital standards, stripped of their implicit federal guarantee, or even broken up, will be disappointed again as Fannie CEO Franklin D. Raines musters his lobbying clout to limit reforms.

Congress may order Treasury to approve any new products Fannie and Freddie want to offer, such as mortgage insurance. Detractors, which include such big lenders as Wells Fargo and Citigroup (C ) say the GSEs have moved far afield of their mission to buy loans from lenders and pool them into instruments known as mortgage-backed securities. Fannie and Freddie argue that pre-approval will stymie innovation, which is likely to fall on deaf ears.

Rivals will have a tougher time winning other curbs. They want the GSEs to meet the same capital standards as banks, both to level the playing field and cut risk. By law, Fannie and Freddie must hold in reserve at least 2.5% of their on-balance-sheet assets, vs. 4% banks must hold against their home loans. But OFHEO Director Armando Falcon Jr. says the lower reserve is sufficient. "While banks engage in a broad array of loans, some of which are riskier than mortgages, [Fannie and Freddie] just have mortgage assets," he says. That logic suits lawmakers, especially Democrats, who fear that a higher standard would reduce the GSEs' overall mortgage financing, making it harder to fulfill their mission of fostering affordable housing.

Fannie and Freddie are also likely to deflect efforts to limit their investment portfolios. Critics say their combined $1.6 trillion of investments makes them more like hedge funds with an implicit government safety net. Fannie and Freddie, which get the majority of their profits from such investments, insist the risk is well-managed by hedging. Lawmakers, afraid that curbing the GSEs' investment freedom could nudge interest rates higher, will probably agree.

In the end, Fannie and Freddie are likely to get off lightly -- unless Freddie Mac's accounting woes worsen. With Freddie expected to restate three years' worth of earnings in late September, fresh revelations could yet spur a Hill crackdown. That also might give credence to arguments, now made sotto voce, that the real problem is that Fannie and Freddie have grown too big and present too much risk. But for now, fear of disrupting the great American mortgage binge has convinced Washington that it's safer just to tinker.

By Amy Borrus and Paula Dwyer

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