ROYCE: Inevitable collapse

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By Ed Royce

OP-ED:

Much of the debate in Washington lately has focused on the Treasury Department's proposal to address the current market turmoil through a $700 billion program. While overleveraging and poor investment decisions were large contributors to our struggling economy, Congress and the federal government must also share a good portion of the blame.

The Treasury Department's takeover of Fannie Mae and Freddie Mac marks the official failure of this private-public experiment which was concocted by Congress in the 1960s. Yesterday, the Financial Services Committee finally revisited this issue and addressed the move to put Fannie and Freddie into conservatorship and dedicate as much as $200 billion to these companies. This step was regrettable but necessary given the potential systemic shock a failure of these behemoth institutions would have had on our capital markets.

For years, many in Washington looked the other way and to some extent exacerbated the problems that led to the eventual collapse of these companies. The assumption that the federal government would step in if the government-sponsored enterprises (GSEs) ran into trouble created a moral-hazard problem that led to Fannie and Freddie taking on excessive risk. The need for a strong, effective regulator able to control the size of these institutions' portfolios became that much more critical. Unfortunately, the Office of Federal Housing Enterprise Oversight, Fannie and Freddie's primary regulator, lacked credibility — not only in the political arena, but more importantly, in the financial community. Investors saw that lax regulations allowed these firms to run leverage ratios nearly 10 times greater than commercial banks. This overleveraging finally took its toll earlier this month.

When the House considered GSE reform legislation in 2005, I introduced an amendment to give the regulator authority necessary to curtail the systemic risk posed by Fannie and Freddie's portfolios. The amendment was defeated by a large margin, leaving the underlying legislation incapable of curtailing the risk exposure from these portfolios. The opponents of my amendment claimed Fannie and Freddie posed no threat to the financial markets and that systemic risk was "a theoretical term." In reality, the opposition was looking to preserve the status quo and allow Fannie and Freddie to grow at an alarming rate without any meaningful constraints. Had this legislative solution been acted on in a timely manner, the GSEs and our financial markets would surely be in far better shape than they are today.

Those opposed to our reforms also encouraged additional risk-taking by the GSEs under the guise of promoting home ownership throughout the country. In 1992, the Democrat-controlled Congress passed the GSE Act, which established the current regulatory structure for Fannie and Freddie. The bill mandated that the GSEs devote a percentage of their business to three specific affordable housing goals each year. This marked the first time Congress gave Fannie and Freddie explicit mandates to target low-income and underserved communities. These mandates skewed the marketplace and provided excessive liquidity to the lending institutions making loans to individuals that could not afford them. This move also exposed the GSEs to a riskier class of loans, which required little documentation and greatly contributed to their losses. All of these factors ultimately led to the demise of Fannie and Freddie.

Congress's failure to pass such critical legislation over the years, especially since the mortgage industry began to deteriorate 18 months ago, is one of Washington's greatest oversights in recent history. As home prices declined and mortgage losses mounted, both companies' capital levels began to erode rapidly. Instead of acting in a timely manner, the Democratic leadership in Congress saw an opportunity to delay the process in order to include some of their pet projects, like an affordable-housing fund that funnels hundreds of millions of dollars to radical political organizations.

Over the years, Fannie Mae and Freddie Mac have leaned heavily on their implicit government guarantee because they were unable to stand on their own. While the final cost of this aid remains unknown, the taxpayers that have funded the bailout deserve a complete overhaul in the way these companies are treated by the federal government. Considering Washington's many failures in the handling of Fannie and Freddie over the last two decades, the status quo is not an option. Following this difficult period in our capital markets, the GSEs quasi-governmental status must come to an end. If it is not addressed, the risk posed by these institutions will remain and the American taxpayers will, yet again, pay for Washington's mistakes.

Rep. Ed Royce, a California Republican, is a senior member of the House Financial Services Committee.