White House Sets Forth Plan To Limit Size of Fannie, Freddie

The Bush administration has backed legislation that could substantially reduce Fannie Mae and Freddie Mac's investment holdings, part of an accelerating push to shrink the size and influence of the mortgage companies.

Hours after Federal Reserve Chairman Alan Greenspan called for strict limits on the two companies, the administration yesterday delivered its proposal for tighter regulation of Fannie and Freddie to House Financial Services Committee Chairman Michael G. Oxley (R-Ohio).

Oxley's committee is slated on Wednesday to consider legislation that would create a more powerful regulator for Fannie and Freddie. The Senate is expected to consider a similar bill in late June, part of a legislative backlash to accounting scandals at the two companies.

A senior administration official familiar with the administration's proposal said it would let the new regulator limit the amount of mortgage investments Fannie and Freddie can hold on their books, as opposed to reselling them to investors.

The size of Fannie and Freddie's investment holdings has become the central focus of debate among lawmakers working to create a new independent agency to replace Fannie and Freddie's current regulator, the Office of Federal Housing Enterprise Oversight. OFHEO last year uncovered accounting violations at Fannie Mae that led to the ouster of top executives and the possible restatement of as much as $12 billion in previously reported earnings.

Critics of Fannie and Freddie, including Greenspan, have long argued that by holding more mortgages and mortgage-backed securities for investment purposes, the two companies are exposing themselves -- and the U.S. financial system -- to greater levels of risk.

Greenspan, speaking yesterday via satellite to a housing finance conference in Atlanta, said the risk of a problem or financial collapse at two "huge, highly leveraged" companies like Fannie and Freddie is "not conducive to the long-term financial stability that a nation of homeowners requires."

The administration's proposal would give a new regulator the power to limit Fannie and Freddie's ability to make investments that are only intended to increase their profits.

Much of Fannie and Freddie's business involves buying mortgages from retail lenders and repackaging them for investors around the world. That role as middleman for the mortgage industry is lucrative in itself and is also crucial to keeping money available for home buying: When Fannie or Freddie buys a mortgage from a bank, it frees the bank to make more loans.

Since the early 1990s, however, the two companies found it was more profitable to hold onto mortgages rather than remarket them, a practice that boosted earnings for stockholders and helped trigger millions of dollars in bonuses for top executives. But it also exposed Fannie and Freddie to more risk if borrowers defaulted or interest rates began rising -- risks that lawmakers, Greenspan, and others contend would ultimately be borne by taxpayers because the two companies are government chartered.

The changing investment strategy also led Fannie to manipulate its accounting to inflate its earnings, according to OFHEO.

Under the administration's proposal, Fannie and Freddie would be allowed to hold "only those assets that are necessary to provide a liquid and efficient secondary mortgage market," the administration official said. That, for example, would include the small portion of mortgages granted to home buyers that meet the guidelines of the two companies but would not be attractive to other investors.