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Tuesday, October 11, 2005

Should Fannie and Freddie Be Forced to Go on a Diet?

There has been a lot of talk about reforming Fannie and Freddie Mae.  Here's a commentary from the WSJ by Armando Falcon, director of Office of Federal Housing Enterprise Oversight from 1999 until May of this year on this issue.  He contends that regulators must be given the power to regulate the size of these institutions:

Adult Supervision, by Armando Falcon Jr., Commentary, WSJ: Over the past several years, corporate America has been rocked by major scandals... Whether it was Enron, Adelphia or WorldCom, Congress wasted no time examining and strengthening the oversight functions and regulatory authority of various federal agencies, including passage of the wide-ranging Sarbanes-Oxley Act. To date, there remains one glaring exception. In the past two years, accounting failures at Fannie Mae and Freddie Mac, known as Government Sponsored Enterprises (GSEs), have led to the largest financial restatements in history -- totaling more than $20 billion -- dwarfing the combined restatements of both Enron and WorldCom. In recent days, news reports indicate the financial misconduct could be wider and deeper than has emerged thus far. Left undetected and unchecked, the web of misconduct ... might have ... caused serious disruptions to our financial system. The likely collateral damage was presciently spelled out in a report on systemic risk that their regulator, the Office of Federal Housing Enterprise Oversight (Ofheo) issued in 2003. Yet  ... two and a half years after Freddie Mac's scandal unfolded, legislation to strengthen regulation remains mired in gridlock. One of the key areas of disagreement is the appropriateness and size of the mortgage portfolios these enterprises retain. ... The fact is that they have grown 12-fold in 14 years for one reason: to generate additional profits for the GSEs. That is nonjudgmental, just a fact. ... Currently, there are no real limits on the size of the portfolios. Ofheo's statutory mandate [does] not to limit their amount. However, Fed Chairman Greenspan and other economic leaders have repeatedly warned policy makers that they should be concerned...

Smaller, mission-focused portfolios would better serve everyone, even shareholders. If well managed, they are capable of a fair return to investors and a strong return to the public interest. ... Legislation should give the regulator discretion to manage the size of the portfolios, but be clear as to the regulator's mandate. The mandates in the Senate and House bills are very different ... The Senate bill would direct regulators to design and implement an orderly reduction in the enterprises portfolios without harm to affordable housing efforts. But the House bill ... permits the enterprises to maintain portfolios of any size as long as safety and soundness considerations are met. The House bill should be amended to put the proper mandate in place.

...Fannie Mae and Freddie Mac have constructed their portfolio risk-management strategies around hedging techniques that remain untested by adverse market conditions. Even assuming the companies employ the very best risk-management practices, prudence demands that we have the strongest regulatory structure in place to deal with the fallout if they just get it wrong. ...The growth of the portfolios held by these two GSEs has coincided with a strong economy, except for a mild recession in 2001 that left the housing sector unaffected largely because interest rates fell to historic lows. However, long-term interest rates are more likely to begin an upward trend that may cool off the housing market. ... Freddie Mac and Fannie Mae play an important role in our housing finance system and I support their public mission. The key is to ensure they are truly focused on this mission in a safe and effective manner. If this public-private arrangement is to work, the enterprises must have a fully empowered regulator and get back to serving the public interest, not the ambitions of management.

When the WSJ is calling for more, not less government regulation, it catches your attention.

    Posted by on Tuesday, October 11, 2005 at 01:20 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (12)


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