Regulators Talk Tough, but Fannie, Freddie Still a Risk

By Reuters -  |  Posted 2008-07-14 Print this article Print

U.S. regulators and politicians are doing whatever it takes to shore up Fannie Mae and Freddie Mac. A new plan allows for more government loans and options for regulators to buy certain securities to increase their capital.

WASHINGTON (Reuters) - While the Bush administration was urging Wall Street to use market discipline to curb lax lending in the worst U.S. housing downturn in decades, its regulators were loosening the reins on Fannie Mae and Freddie Mac.

Taxpayers will now foot the bill.

Amid fears of one of the biggest financial debacles in history, U.S. regulators and politicians are doing whatever it takes to shore up Fannie Mae and Freddie Mac, the twin pillars of the U.S. mortgage market, to reassure financial markets around the world.

The plan, announced on Sunday night, allows for more loans from the government and the option for regulators to buy certain securities issued by these companies to increase their capital.

Senior Treasury officials stated over the weekend that they had seen no deterioration in market conditions for debt from these companies, and as they had predicted Freddie Mac's issuance of new notes went off without a hitch on Monday.

But experts from both sides of the political aisle say that troubles at these financial behemoths have grown while the administration officials had the tools at hand to mop up the mess.

And they warn that the price tag might prompt Wall Street titans and ordinary taxpayers alike to reach for the Maalox or Zantac: a complete bailout of these huge mortgage finance players could double the fiscal deficit.

"We are not in a position any more not to bail them out," said Peter Wallison, an expert in financial deregulation at the American Enterprise Institute, who worked at the U.S. Treasury Department during the Ronald Reagan administration.

"We must keep this game going in the sense that the U.S. government must continue to stand behind them," Wallison said.

"It's the largest case of moral hazard," he added.

For years, Wallison has warned that the government's implicit backing of Fannie Mae and Freddie Mac poses the danger of "dumbing down" the risk-taking decisions made by market participants, particularly as the business of Fannie and Freddie expanded to account for the bulk of American mortgage activity.

Fannie Mae and Freddie Mac own or guarantee $5 trillion of mortgages, nearly half of all U.S. mortgages.

Efforts that began in the Clinton White House and continued through the Bush administration to boost home ownership, particularly among Americans in minority groups and with lower incomes, were what helped drive a surge in Fannie Mae and Freddie Mac activity. Supporters in Congress egged them on.

Chartered by Congress, but with its stock publicly traded, Fannie Mae and Freddie Mac buy mortgages, guarantee them, and then reissue them as securities, including mortgage-backed bonds.

Fannie Mae's pedigree goes back to the 1930s, when the American economy was devastated by the Great Depression that followed the stock market crash of 1929. Created as part of Franklin Delano Roosevelt's New Deal to provide funding for home mortgages, Fannie Mae later became a publicly traded company with its stock listed on the New York Stock Exchange.

Freddie Mac was created decades later to give Fannie Mae some competition in the secondary market for home mortgages.

Over the past several years, these two companies, known as government-sponsored enterprises, or GSEs, have grown rapidly amid the pressure from the White House to boost home ownership, which has persisted even as fears of a collapse grew.


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