Fannie, Freddie Face Conflicting Demands

Fannie Mae chief Daniel Mudd faces a new political reality in which his firm is expected to help solve the mortgage crisis while turning a profit.
Fannie Mae chief Daniel Mudd faces a new political reality in which his firm is expected to help solve the mortgage crisis while turning a profit. (By Manuel Balce Ceneta -- Associated Press)
By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, December 4, 2007

As policymakers call for Fannie Mae and Freddie Mac to help large numbers of homeowners avert foreclosure, they are running up against other interests -- not the least, the companies' obligation to deliver profits to shareholders.

At a Washington conference yesterday, some housing industry leaders said the giant federally chartered businesses Fannie Mae and Freddie Mac were created to tackle problems like the current mortgage crisis and should be given greater license to intervene.

"We're in a terrible cycle. My answer is to jump-start the mortgage market. Fannie and Freddie have to play a major role here," said Angelo R. Mozilo, chairman and chief executive of Countrywide Financial, a big lender.

The fact is, the missions of Fannie Mae and Freddie Mac have long been muddled, and their mandates contain built-in conflicts, chief among them the pressure to make money as well as serve the public interest.

The companies' supporters in Congress have argued they can balance the competing demands.

"Our job is to help those who house America," Fannie Mae spokesman Brian Faith said by e-mail.

Others say the contradictions have contributed to the companies' troubles over the years, including badly neglected internal controls and alleged accounting manipulations at Fannie Mae that a federal regulator says were fueled by the desire to enrich executives.

Fannie Mae, based in the District, and Freddie Mac, based in McLean, were established to keep money flowing to mortgage lenders. They perform two major behind-the-scenes functions. First, they package pools of loans into securities for sale to other investors. In the process, they affix their own guarantee that they will make good on the loan payments if the borrowers default. Second, Fannie Mae and Freddie Mac buy and hold mortgages and mortgage-backed securities in their own investment portfolios.

Fannie Mae was established in the 1930s, when the country was grappling with the fallout from the Great Depression. Freddie Mac was created by the savings and loan industry in 1970. They provided vehicles for lenders to get mortgages off their books and replenish the funds needed to make new loans.

Though both Fannie Mae and Freddie Mac later became stock-market corporations, they retained ties to the federal government, which helped them become dominant players in their niche. Federal sponsorship has contributed to a widespread perception in the financial markets that the government would stand behind them if they became insolvent.

The companies and the government disavow any such assurance. Nonetheless, they have been able to borrow money at unusually low rates, and the bonds they issue are regarded as some of the next best things to U.S. Treasury bonds in terms of risk of default. In Wall Street parlance, securities issued by Fannie Mae and Freddie Mac are known as "agency securities," though the companies are not agencies of the U.S. government.

As a former chairman and chief executive of Freddie Mac tells it, the original idea was that Freddie Mac would disappear a few years after it was created. It would show Wall Street how to provide a secondary market for mortgages, and when Wall Street followed its example, Freddie Mac would be liquidated, former Freddie Mac chief Leland C. Brendsel recently recounted.

But few institutions willingly go out of existence, and today Freddie Mac, like Fannie Mae, has big constituencies, from shareholders and bondholders to builders, lenders, real estate agents and Wall Street firms that see the companies as buyers of last resort for troubled mortgage securities.

The government expects Fannie Mae and Freddie Mac to uphold prudent lending standards. However, it has dictated that they help low-income populations buy homes by meeting a complicated set of affordable housing goals or quotas. Those requirements helped prompt the companies to invest billions of dollars in subprime loans, contributing to the popularity of the mortgages.

"Subprime investments are now necessary to the achievement of our affordable housing goals," said Sharon J. McHale, spokeswoman for Freddie Mac.

Faith, the Fannie Mae spokesman, said such loans have been a relatively small part of the company's overall business.

Fannie Mae "gave up considerable market share due to our concern about some of the more unconventional products out there and the direction the market was heading," Faith said.

Longtime critics at the Federal Reserve have argued that investors may subject Fannie Mae and Freddie Mac to less stringent market discipline because the notion that the government stands behind the companies trumps the details of their financial condition.

Although accounting problems and flawed internal controls left the companies unable to provide timely reports on their finances for years, investors generally took the situation in stride. Last week, Freddie Mac had no trouble raising billions of dollars needed to ensure continued compliance with federal capital requirements. Both companies' stocks have, however, taken a beating in recent weeks.

The companies have been calling for their regulator, the Office of Federal Housing Enterprise Oversight, to raise limits on the volume of mortgage-related investments they may hold. They and prominent Democrats have been arguing that they could help ease the credit crunch.

But OFHEO's director, James B. Lockhart III, recently said that Fannie Mae and Freddie Mac became less enthusiastic about congressional efforts to raise the portfolio caps after lawmakers proposed that most of the additional investment go toward helping borrowers with subprime loans.

Staff writer David Cho contributed to this story.

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