- The Washington Times - Tuesday, February 24, 2004

Federal Reserve Chairman Alan Greenspan yesterday took on the powerful housing industry, warning that the $2 trillion and growing debts being amassed by Fannie Mae and Freddie Mac pose a threat to the economy and taxpayers.

The two mortgage giants played a historically important role during the 1980s and 1990s by helping to create an investor market for mortgage-backed securities, enabling home buyers to enjoy lower interest rates and easier credit terms while contributing to record homeownership rates, Mr. Greenspan told the Senate banking committee.

But the government-sponsored enterprises, in their race to become Fortune 500 companies, have exploited their implicit federal guarantee by monopolizing the market for single-family mortgages in recent years, while rapidly expanding debts and assets in a way that threatens the stability of the financial system, he said.

“The Federal Reserve is concerned about the growth and the scale” of the enterprises’ acquisition and debt activities, and recommends that they be capped by Congress to prevent a financial crisis in the future, he said.

“Preventive actions are required sooner, rather than later,” he said, echoing warnings from the General Accounting Office and Congressional Budget Office.

While the enterprises were not large enough in past years to “create a potential significant problem” for the economy and taxpayers, “they will almost surely do so in years ahead unless some changes are made,” he said.

Mr. Greenspan advocated strict regulation of the enterprises comparable to the strictures imposed on their competitors, big banks like Citicorp and Bank of America. Among other things, the banks are required to set aside substantial reserves to cover losses from loan delinquencies.

Fannie Mae and Freddie Mac, despite having unprecedented amounts of debt, are not required to keep reserves against losses, and the lack of regulatory burden has given them a substantial advantage over competitors, Mr. Greenspan said.

In addition, little of the benefit they receive from billions of dollars in implicit federal subsidies is passed on to homeowners in the form or lower interest rates, he said.

The debt obligations of the agencies enjoy lower interest rates because investors assume that they are federally guaranteed, even though Congress has provided no explicit guarantee. This yields only a small benefit to homeowners, however, estimated at between 0.07 percentage points and 0.35 percentage points on a typical mortgage of 5.58 percent.

It is the stockholders and executives running the enterprises, rather than homeowners, that primarily benefit through increased profits, Mr. Greenspan said.

The Fed chairman’s testimony provoked an outraged response from housing advocates, who portray the substantial advantages enjoyed by Fannie Mae and Freddie Mac as critical to nurturing the housing boom that buoyed the economy during the recession.

Congress, heeding warnings that stricter regulation of the enterprises would cut short the record spate of home sales, has put off legislation since Freddie Mac’s $5 billion manipulation of earnings was revealed last year.

“I have learned a lesson a long time ago about not biting the hand that feeds you, and I would think Mr. Greenspan and the Fed would have learned the same message,” said Jerry Howard, chief executive of the National Association of Home Builders.

Many economists would argue, however, that it was the 40-year low in interest rates engineered by the Fed that produced today’s boom in home sales and construction.

Fannie Mae, whose lobbying clout in Congress has few equals, said it opposes caps on its activities.

“Limits on Fannie Mae’s mortgage portfolio business would force the housing-finance system to rely more on large banks, which are not required or structured” to reduce mortgage costs, said Jayne Shontell, a Fannie Mae senior vice president.

“Our mortgage portfolio helps to provide a steady national flow of mortgage funds to all communities.”

Fannie Mae in October disclosed a $1.1 billion accounting mistake it made in the third-quarter. Freddie Mac’s $5 billion mistake led to the ouster of two chief executives and the company’s president last year.

Mr. Greenspan stressed that the corporations are well-run and are not in any immediate financial danger in part because they employ hedging strategies aimed at minimizing the biggest risk they face: a sudden rise in interest rates that could devastate the value of their portfolios. But he said it would be impossible for them to fully insure against such risks.

Mr. Greenspan added that he is not opposed to Congress providing more subsidies for homeownership because it promotes respect for private property, stability in communities and other social benefits.

“The expansion of homeownership is a widely supported goal in this country,” but it can be done more efficiently through other government programs such as those that provide credit insurance and help with down payments for first-time home buyers, he said.

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