Home >> United States & Canada >> Economics & Trade

     Email   Print 

Fannie Mae and Freddie Mac Regulation: Even More Dangerous Than Usual

Ross Kaminsky - 6/16/2005

For several years there have been calls for reform of Fannie Mae and Freddie Mac, the quasi-governmental mortgage giants. Because of their implied Federal guarantees, these companies seem to take much more risk than any similar independent company would, taking huge positions in mortgages with less reserve capital than is required for similar organizations.

Both companies have expressed willingness to accept stricter regulation of their portfolios and capital requirements, and Alan Greenspan has recommended that these steps be taken.

According to the American Enterprise Institute (see link above), "To place this in some perspective, all Treasury debt held by the public totals $4.4 trillion, and all corporate bonds outstanding total $2.9 trillion. Fannie's and Freddie's liabilities--including both their MBS guarantees and their borrowings--come in right in the middle, at $3.7 trillion. Thus, only two companies--both of which are GSEs and implicitly backed by the U.S. government--account for more default risk than all other U.S. corporations combined. The risks for the taxpayers are obvious, but as many commentators have also pointed out, risk of this size, if concentrated in only two companies, poses a danger to the U.S. economic system as a whole--a danger known as systemic risk."

The Republican Policy Committee has said that the $1.5 trillion mortgage portfolios held by Fannie and Freddie serve "no credible purpose". (According to the Reuters report noted above.)

Note that while I am not generally a fan of regulation, this is a special case because these companies operate under the protection of the government and thus do not operate constrained by financial prudence which most private or public companies must exercise to survive. Furthermore, if a company is going to rely on taking our tax money to cover their future disasters, we should have the right to minimize the chance and scale of such disasters. Essentiallly the government is allowing Fannie and Freddie to generate higher profits for its shareholders by using citizens as unwilling or unknowing insurers of their portfolios. I'm all for profits, but they must be earned fairly and not on the backs of taxpayers.

Along comes the House Financial Services Committee, chaired by Rep. Mike Oxley (R-OH), which has decided to approach the problem by establishing a new regulator without enough power to control the size of the companies' portfolios. Even the Bush administration, no fan of corporate regulation, says the bill is simply too weak.

But it gets worse, the bill includes a provision for the companies to contribute 5% of their profits to non-profit or for-profit organizations which develop or finance low-income housing. It's ironic that the Washington Examiner (see link above) says that "efforts by Democrats to reshape the bill generally failed in the GOP-controlled committee." It's hard to imagine a proposal more redistributive (socialist) than this; the Republicans have done the Democrats' work for them. The Wall Street Journal estimates this payola for the housing industry and liberal social groups at $3 billion over five years.

Not only does this bill do nothing to address the fundamental risks to our economy of the way these companies operate, and not only does it not limit the potential bill to the taxpayers, but it then turns the companies into cogs in the welfare state machine.

The reason the 5% provision is so dangerous is that it will then cause Democrats to argue against reform of Fannie and Freddie because limiting their ill-gotten profits will "hurt the poor". The Republicans will argue against reform because the 5% goes to their friends in the housing industry.

If the government can grab 5% of this pot for their pet projects and the welfare state, what government program might next be expanded (or at least not kept in check) under the watchful gaze of Congress, with knowing winks between the do-gooder Democrats and the Republicans who never saw a business subsidy they didn't like. With "divided government" like this, who needs cooperation?