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Correction to This Article
A Dec. 20 Washington Business article incorrectly identified Peter J. Wallison, a resident fellow at the American Enterprise Institute, as an economist. He is a lawyer.

A Special Status Examined

Economists Differ on Value of Government Charters

By Terence O'Hara
Washington Post Staff Writer
Monday, December 20, 2004; Page E10

Their advertising focuses on the "American dream" of homeownership. They stand behind nearly half of the home mortgages in the country, making Fannie Mae and Freddie Mac, by asset size, the second- and third-largest companies in the nation, after Citigroup.

Yet long before the accounting problems that rocked Freddie Mac last year and Fannie Mae recently, there's been a growing call in Washington to rein in the housing finance giants and cut their ties to the government.

_____Graphic_____
Impact on the Mortgage Market Fannie Mae is the Washington area's largest company and the nation's leading source of home mortgages, involved in about one out of every five mortgages.
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Problems Won't Affect Move, Developer Says (The Washington Post, Dec 20, 2004)
Scandal Boosts Oversight Agency's Reputation (The Washington Post, Dec 20, 2004)
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Congress Puts New Regulator on the Fast Track (The Washington Post, Dec 20, 2004)
Reassuring Answers (The Washington Post, Dec 20, 2004)
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"We don't need them," said Peter J. Wallison, an economist and resident fellow at the American Enterprise Institute. "They produce very little of any value to the housing market."

Wallison's view is widely shared in the private-sector secondary mortgage market, where competitors chafe at Fannie Mae's and Freddie Mac's government-sponsored benefits. But even with the problems at the two companies, Congress is not expected to change Fannie Mae's and Freddie Mac's structure or charters, experts and lawmakers said last week.

That's because both companies, with their vast size and peculiar status, have put down deep roots in the financial system. Tinkering with their business could cause unintended consequences, said Jay Cochran III, a research fellow in regulatory studies at the Mercatus Center at George Mason University.

"One would hope that we could have real change," he said. "But that remains to be seen. It's really a political question."

Spokesmen for the two companies declined to comment, but in the past the firms have staunchly defended their blend of government charter and private enterprise, claiming that it reduces borrowing costs for homeowners and assures ready cash for home lenders.

The companies ply their business in a number of ways.

First, they buy mortgages from banks, savings and loans, and other mortgage lenders, freeing those lenders' cash to make more loans. Fannie Mae and Freddie Mac pay for those mortgage purchases by selling bonds in the public markets. They also guarantee mortgage-backed securities, investments sold on the open market that are backed by pools of thousands of home mortgages. The system is known as the secondary mortgage market.

Both before and after Fannie Mae and Freddie Mac became private companies, the system helped make credit widely available.

It also made Fannie Mae and Freddie Mac gigantic and made their stockholders and executives wealthy. The firms have a combined market value of more than $100 billion, roughly four times their worth 10 years ago. At the end of 2003, Freddie Mac had more than $1 trillion in assets and Freddie Mac had more than $800 billion, made up mostly of mortgage loans, each other's bonds, mixed securities and cash.

Because they were chartered by Congress, both companies have the implied, if not legally binding, backing of the government. That allows them to sell bonds at lower interest rates in the open market because investors perceive them as safer.

Finally, Fannie Mae and Freddie Mac securities -- their bonds and mortgage-backed securities -- are one of the basic tools of financial-institution spreadsheets in the United States and abroad. U.S. banks buy billions of dollars worth of them a year. Further, because of the perceived safety, federally insured financial institutions can hold high concentrations of the government-sponsored-enterprise securities, well above that allowed of other securities.

Those many tentacles into the financial system are the main reason why some -- most prominently Federal Reserve Chairman Alan Greenspan -- have expressed concern about "systemic risk." That is, under their current structures, if Fannie Mae or Freddie Mac falter, the shock to the system could be too great, and the financial risk to the government too heavy, to bear.

"My personal belief is that Congress has put an apple before the management of Fannie Mae. It's understandable that they bit," said Rep. Jim Leach (R-Iowa), who as chairman of the House Banking Committee in the 1990s often criticized aspects of Fannie Mae and Freddie Mac.

Leach said he was troubled by the accounting problems because he had always considered the companies well managed. "When you privatize profit and socialize risk, it's a prescription for lack of discipline," he said.

If Fannie Mae and Freddie Mac's government status were removed, what would happen?

Very little, Wallison said. The secondary market for loans that Fannie Mae and Freddie Mac don't buy "works perfectly well." Private-sector financial institutions, able to compete on the same terms for capital, would probably rush to fill the gap, he said.

Whatever benefits Fannie Mae and Freddie Mac passes on to homeowners in the form of slightly lower rates -- the most liberal estimate is about a quarter of a percentage point off an interest rate -- would be compensated for by more competition, Wallison said.

"If we did not have Fannie Mae and Freddie Mac, we would have a very vigorous, large secondary mortgage market today," he said. The American Enterprise Institute has long argued for less government involvement in private enterprise.

Other observers said the social benefits of keeping Fannie Mae and Freddie Mac close to the federal government outweigh the risks -- as long as each is regulated properly.

"An argument against privatizing them is there's always going to be some political interest in having an entity like Fannie Mae and Freddie Mac," said James E. Pearce, an economist at Welch Consulting in College Station, Tex. Pearce co-authored a 2001 study, partially funded by Freddie Mac, about the benefits of the company's government charters. "Taking them out of the government sphere of influence entirely . . . would make them look more like GE Capital or like some other large financial institution. They would not have the social responsibilities they have now, and would not be an outlet for members of Congress and the executive branch to influence the flow of credit in particular ways. If they did away with them, they would have to come up with something else to take their place."


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