Shine A Hard Light On Fannie Mae

It's time for real oversight -- perhaps from Treasury

Should we break up mortgage giant Fannie Mae (FNM )? Is it so big and out of control that it threatens the entire U.S. financial system? A lot of people in Washington think so, especially after the 211-page broadside against it by the Office of Federal Housing Enterprise Oversight (OFHEO) on Sept. 22. Unfortunately, the financial questions about Fannie Mae are entwined with ideological battles between Republicans and Democrats. The truth is hard to come by. Yet one thing is increasingly clear: At the least, Fannie Mae and its smaller sibling, Freddie Mac (FRE ), need a more sophisticated and powerful regulator.

Fannie Mae has fended off the kind of oversight common to other financial institutions. And OFHEO, which belongs to the Housing & Urban Development Dept., has been a weak regulator. It did bring to light possible accounting problems at Fannie Mae (which were denied by CEO Franklin Raines in Congressional testimony on Oct. 6). But the alleged manipulation of earnings may have started as early as 1998. Where was OFHEO? And just last summer serious accounting errors at Freddie Mac were disclosed. Where was OFHEO? It's time for serious, sustained oversight. Our choice is the Treasury Dept., which already regulates national banks

It's also time for definitive information on just what Fannie Mae and Freddie Mac contribute to our economy. Fannie Mae, lest we forget, was a pioneer in the '80s and '90s in securitizing debt, spreading risk, and expanding financial markets. This developed national secondary-mortgage markets for home loans and revolutionized the car, credit-card, and commercial mortgage-loan markets.

But research by the Federal Reserve suggests that today Fannie and Freddie may be far less useful to homeowners than many had assumed. Their enormous financial activities may lower mortgage rates by only seven basis points. Much of the savings from its implicit government backing appears to be going to shareholders in the form of higher profits and dividends. Fannie's managers also gain through their compensation. Fannie says it's own research shows big benefits for homeowners. We need to know if this is true.

We also must understand how much risk Fannie Mae poses to the financial system. Federal Reserve Chairman Alan Greenspan, a critic of Fannie Mae, told Congress in February that he is worried. Fannie Mae is the second-largest issuer of debt in the U.S., behind only the federal government. The immense size and scale of Fannie and Freddie may be making the financial system more vulnerable to unforeseen shocks. Greenspan wants to prevent that by slowing Fannie and Freddie's expansion. To do it, he would raise their capital standard. It's a prudent idea.

Fannie Mae has played a critical role in expanding homeownership in America, especially among first-time, minority, and low-income buyers. But there are serious questions that must be addressed about its governance, its benefit to society, and its risk to the financial system. This is not simply politics. It is an economic issue.

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