Now Fannie fumbles, too

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Fannie Mae's announcement Wednesday that it made a $1.1 billion error on its third-quarter balance sheet appears to validate calls for regulatory reform of the mortgage giant and its close relative, Freddie Mac. Still, Congress and the administration must ensure that any changes in oversight bolster transparency and confidence in regulatory structures, without impeding Fannie's and Freddie's ability to drive brisk home-buying -- a critical locomotive for America's economic growth, even during times of weakness.

In light of the accounting imbroglio at Freddie Mac, Fannie Mae had been held up by opponents of regulatory reform as a larger, more financially responsible company. The transparency at Fannie, they argued, proved that Freddie's understatement of $4.5 billion in earnings between 2000 and 2002 was just an aberration. But Fannie's fall from financial grace seriously weakens this argument.

Fannie Mae and Freddie Mac are among the four largest financial institutions in America. The companies buy mortgages from banks and savings and loans. They also repackage some of those mortgages and sell them as securities, known as mortgage-backed securities. In 1970, Congress gave Freddie Mac its charter, and Fannie Mae completed its transformation from a public entity to a government-sponsored private company. Given their government charter, the companies face less stringent disclosure requirements than other publicly traded companies, and are widely, if erroneously, believed to be guaranteed by the government against default.

Given the size of Fannie and Freddie and their detachment from some free-market pressures, effective oversight is critical. But Congress should refrain from placing undue regulatory burden on the companies, given their importance to the general economy.

The National Association of Home Builders (NAHB), whose members will construct most new housing units in the country, has floated a carefully tailored policy proposal that addresses the areas where problems have emerged. Under their plan, an independent body would be created in the Treasury Department to broadly regulate accounting at Freddie and Fannie, including oversight of derivative reporting, where Freddie Mac has run into billion-dollar problems. Oversight of new projects would be shared by the Departments of Housing and Urban Development, where these issues are currently regulated, and Treasury.

"Mistakes of recent months demonstrate a closer look at safety and soundness issues is warranted," said NAHB's CEO, Jerry Howard. "But there's no need to go overboard and ignore the housing mission that the institutions were chartered for." Mr. Howard also said the perception in the housing market is that Treasury could have an institutional bias against some policies geared toward affordable-housing.

Congress is unlikely to vote on policy changes for Fannie and Freddie this year. But the problems at Fannie Mae have put new impetus behind the legislative efforts. Congress should approve effective but restrained regulatory reform early next year, if the issue isn't resolved before this year's recess.