Fannie Mae executives in recent years shifted the company's investment strategy to drive up Fannie's earnings and stock price and away from the company's government-chartered mission to promote homeownership, the company's chief federal regulator said yesterday.
By holding increasing amounts of mortgages in Fannie's portfolio -- purchased at lower-than-market interest rates subsidized by the government -- Fannie executives were able to meet earnings targets that, in turn, triggered millions of dollars in bonuses for themselves.
Since the 1980s, Fannie's basic business has been to buy mortgages from banks and other lenders and repackage them into securities that it resells to Wall Street investors, a strategy it devised as the lowest-risk way for the company to keep mortgage money plentiful and promote homeownership. But with the lower risk, profit margins narrowed, so the company began pursuing a riskier and potentially more profitable strategy of holding loans on its own books, benefiting from the difference in interest rates charged to home buyers and those that Fannie paid to buy the loans.
Most of that profit, federal officials say, went to Fannie investors and executives, not to home buyers.
"Beyond some basic levels, the portfolio was the means by which the company was able to promise investors double-digit earnings growth for five years," Armando Falcon Jr., director of the Office of Federal Housing Enterprise Oversight, said after testifying before the Senate Banking Committee yesterday.
"It was profit-driven," he said, referring to Fannie's earnings growth. "At some point, enough is enough."
Fannie Mae officials declined to comment about Falcon's remarks. Officials at Freddie Mac, Fannie Mae's smaller rival that has pursued a similar profit strategy, also declined to comment.
Falcon, who is stepping down in May, made what is likely to be his last appearance before Congress as OFHEO director. Lawmakers are considering replacing OFHEO, which is an office within the Department of Housing and Urban Development, with a more powerful independent regulator to oversee Fannie Mae and Freddie Mac.
Last fall, after OFHEO uncovered accounting failures at Fannie Mae, the company agreed to restate $9 billion in earnings, and in December its board forced out Franklin D. Raines as chief executive. Among other things, OFHEO found that Fannie had taken improper steps to offset the very risks it incurred by keeping more loans in its portfolio. Until Fannie's and Freddie's accounting troubles surfaced, the two companies had successfully wielded their considerable political and lobbying clout to defeat prior attempts at tougher oversight.
Falcon told the Senate panel that he agrees with Federal Reserve Chairman Alan Greenspan that Congress needs to give the new regulator the authority to limit the size of Fannie's and Freddie's portfolios so they are only as large as necessary to keep money flowing into the housing market. Falcon said basing the size of Fannie's and Freddie's portfolios on the companies' abilities to manage the risks associated with their investments -- a standard that Fannie and Freddie support -- would be little improvement over the status quo.
Separately, Falcon said that Fannie officials were cooperating with OFHEO's examination and that he was confident regulators would receive all necessary documents from the company. Last fall, he complained to members of Congress that Fannie officials were not cooperating.
Comptroller General David M. Walker, testifying on behalf of the Government Accountability Office, said the benefits to home buyers of Fannie and Freddie holding so many mortgages in their portfolios was unclear.
Congressional Budget Director Douglas Holtz-Eakin, who also testified, went a step further than Falcon and Walker and said Fannie and Freddie are no longer necessary to support a well-functioning housing market and should gradually be privatized. Doing so would "reduce their risks and costs to the federal government . . . with little change in benefits," Holtz-Eakin said.
The Congressional Budget Office estimated that Freddie and Fannie, along with the network of 12 Federal Home Loan Banks, received about $23 billion of federal subsidies in 2003, $13.6 billion of which reached consumers as reduced mortgage interest rates, Holtz-Eakin said.
