Fannie Mae Slips Another Deadline, Freddie Mac Reform and OFHEO Wants Greater Power
Several things have occurred over the last week or so in the ongoing saga of Freddie
Mac, Fannie Mae and their financial improprieties which date back almost to the
turn of the century.
First, Freddie Mac recently announced that it had voluntarily
adopted a temporary policy of limited growth for its portfolio of retained loans.
The use of the term "voluntarily" may be a bit of an overstatement as the restriction
was in response to a request from the Office of Federal Housing Oversight (OFHEO)
which is the designated regulator for Freddie and for Fannie Mae the two Government
Sponsored Enterprises (GSEs) which effectively run the secondary mortgage market.
Freddie has agreed to keep its mortgage portfolio
at a level
no more than two percent above the level that existed on June 30, 2006 and will
adhere to that level until the company has resumed timely reporting of its quarterly
financial results. The company said its objective was to return to quarterly
reporting following release of full-year 2006 results. The corporation admitted
that "this is a challenging objective, and we need to achieve a number of interim
objectives relating to controls and reporting systems to be successful." No
date was given for achieving that goal.
Fannie Mae, in the meantime, announced that it would once
again fail to file its required quarterly report with the Securities and Exchange
Commission for the quarter ended on June 30, 2006. Fannie has failed to file
quarterly or yearly reports since the scandal surrounding its financial
statements erupted two years ago. Generally a publicly held corporation
that is more than a year delinquent in its financial reporting is de-listed
from the New York Stock Exchange. Fannie Mae, however, was granted a waiver
from this sanction.
A spokesman for Fannie Mae said that the corporation is committed to issuing
a restated financial statement for 2004 by the end of this year and, presumably,
will then begin catching up on more recent reports.
The two GSEs are obviously not moving fast enough to please their chief regulator.
OFHEO Director James B. Lockhart, III, speaking before a committee of the American
Bar Association on August 9 called for more reform of the two
corporations and stronger powers for his own agency.
Mr. Lockhart recapped the problems arising from accounting irregularities stating
that earnings were misstated for an estimated $16 billion dollars (for the two
corporations combined), "fines exceeded one-half billion dollars, lawsuits
will total well over a billion dollars, and remedial costs will exceed $2 billion."
Freddie and Fannie are making progress in fixing their problems, he said, but
it is slower than they or we would like or expect. It will take several more
years and legislation is needed to make sure that the companies do not falter
"From the beginning," Lockhart said, "OFHEO has been no match for the responsibility
assigned to it of being the safety and soundness regulator of Fannie Mae and
Freddie Mac. Together they represent more than a 40 percent share of the residential
mortgage market, a share that has doubled since 1990. This unconstrained
growth led to significant operational problems, mismanagement, and earnings
Lockhart blamed the credit markets for not providing normal market discipline
to restrain growth. During the last 15 years the nations GDP doubled but the
mortgage market tripled. The GSEs' guarantees quadrupled and their portfolios
grew 900 percent. Lockhart said that much of this growth was
based on the corporations' GSE status rather than their balance sheets.
He stressed that such wild growth can cause market, credit, and operational
risk but most importantly systemic risk. Financial difficulties of such an institution
could disrupt the financial sector enough to transmit problems to other financial
institutions or markets with which it is interdependent. For example, he said,
60 percent of U.S. banks have more than half of their capital invested in agency
Two bills in Congress, one passed in the House and the other
approved by the Senate Banking Committee, contain many features which will help
prevent problems in the future, primarily by strengthening OFHEO's regulatory
powers Lockhart said. The bills grant the agency powers similar to a bank regulator
- independent litigation authority, receivership, and better enforcement powers,
and also permit OFHEO to seek damages from institution-affiliated parties and
a longer statute of limitations to pursue former employees.
The legislation also seeks to free OFHEO from the appropriations process. Even
though the agency is essentially funded by Freddie and Fannie (much like the
Federal Deposit Insurance Corporation is funded by member banks) it is still
subject to Congressional approval of its budgets and does not always have the
funds available to respond to crises. The bill would also combine the agency
with the Federal Housing Finance Board and free it somewhat from its organizational
chart placement in HUD.
He called for higher minimum capital requirements, currently about half that
required of large banks and asked for explicit authority to set portfolio growth
limits. Fannie Mae's portfolio, he said, has grown 13 percent annually
and Freddie Mac's 26 percent since 1990 to $727 billion and $710 billion
respectively. In contrast the residential mortgage market grew at an average
rate of 8.5 percent. "Absent the agreed upon portfolio limits, Fannie
Mae and Freddie Mac could each increase their portfolios by well over $100 billion
without exceeding the present minimum capital rules including the 30 percent
operational risk requirement that OFHEO imposed."
He denied that limits on portfolios would hurt the GSEs' ability to support
the secondary market and fulfill their missions of liquidity, stability, and
affordability. He said that neither the House nor the Senate bill will limit
the corporations' ability to buy and securitize mortgages which is the key liquidity
mechanism for the secondary market. These mortgage-backed
securities (MBS) not owned by the GSEs represent 26 percent of the total
U.S. mortgage market. OFHEO estimates that less than 30 percent of the retained
portfolios actually contribute to the GSEs' stated mission of affordable housing.
Lockhart concluded by claiming that, were Freddie and Fannie not GSEs, the
market would have made them quickly shrink their portfolio businesses. "The
markets are not performing that discipline and OFHEO does not have the powers
or tools to be a strong regulator, let alone be a substitute for market discipline."