Fannie May Fail Hellen Rittelmeyer • Management Shake-Ups Will Not Solve Basic Problems Winter 2004

On December 21st, Fannie Mae CEO and Chairman Franklin Raines and Chief Financial Officer Timothy Howard resigned as a result of a $9 billion accounting scandal at the mortgage giant. Raines will still receive a $1.3 million yearly pension plus lifetime insurance benefits.

Fannie Mae and Freddie Mac are government-sponsored enterprises, which means that they were founded by the federal government but operate independently and receive funding from stockholders, as though they were corporations. This compromise between state and market combines the worst of both worlds. The minimal regulation and special tax breaks enjoyed by Fannie Mae and Freddie Mac tamper with the natural workings of the housing market, while corporate corruption goes unchecked by a relatively toothless regulatory agency.

Originally, Franklin Roosevelt created the Federal National Mortgage Association, or “Fannie Mae,” to promote home ownership among the poor as part of the New Deal. Fannie Mae buys mortgages from banks, giving them more capital with which to make more loans. Fannie Mae then “bundles” its mortgages and sells them as securities. Lyndon Johnson created the Federal Home Loan Mortgage Corp, or “Freddie Mac,” as a competitor for Fannie Mae in 1970.

The flaws in the system were built in from its beginning. To start, Fannie Mae is not overseen by the Securities and Exchange Commission (SEC), but rather by its own regulatory agency, the OFHEO. The OFHEO, since it is a division of the Department of Housing and Urban Development and not of the Department of the Treasury, does not require Fannie Mae to file reports of its debt to the SEC as normal corporations do. It also lacks the power of receivership normally granted to bank regulators, which would allow it to liquidate Fannie Mae’s assets if the company were ever to become insolvent.

The OFHEO is not likely to grow teeth any time soon; Fannie Mae’s and Freddie Mac’s lobbying budgets are the eighth and second largest of any corporation’s, respectively, and much of those budgets go to blocking reform of the OFHEO.

The assumption on Wall Street is that the federal government would bail out Fannie Mae or Freddie Mac if either were to have a serious financial crisis. This feeling of security allows the two companies to borrow at much lower interest rates, since they are seen as guaranteed, low-risk investments. According to Federal Reserve Board Chairman Alan Greenspan’s February 2004 congressional testimony on Fannie Mae, this below-market borrowing cost causes Fannie Mae and Freddie Mac to grow faster than the housing market and take on more debt than the market would allow.

Congressional Democrats fear that privatizing Fannie Mae and Freddie Mac may increase mortgage rates so much that poor Americans could not get home loans. Yet in December 2003, a report by Fed economist Wayne Passmore revealed that the low interest rates enjoyed by Fannie Mae and Freddie Mac as a result of their government ties are not being passed on to homeowners, as was the government’s original intention. Instead, the profits are absorbed by the companies themselves.

Clearly, government involvement in the mortgage market has led to corruption. The ability to borrow at lower rates is so important to Freddie Mac’s financial success that its accountants falsified records of the company’s profits in order to show investors a smoother and steadier growth rate, preserving its reputation as a safe investment.

Due to Fannie Mae and Freddie Mac’s enormous influence on the U.S. economy, the government would almost certainly bail out either company in the event of an emergency, a bail-out likely to cost more than ten times that of the 1980s savings and loan crisis – all the more reason to privatize the mortgage industry now, before an emergency happens. Removing what are essentially government subsidies in the form of lax regulation and special tax breaks would cut into the profits of Fannie Mae and Freddie Mac executives, but would have virtually no effect on the interest rates homeowners pay. A privatized Fannie Mae would provide a more realistic picture of the housing market and replace the current one, which is distorted by implicit promises of government bail-out. In the long run, all homeowners would benefit.

Helen Rittelmeyer is a freshman in Silliman College.