A Better Watchdog

The Senate should act on a new regulator of Fannie Mae and Freddie Mac.

AMONG THE many ramifications of the subprime mortgage crisis, one of the most striking has been the relative increase in the importance of Fannie Mae and Freddie Mac to the mortgage-backed securities market. To be sure, the two government-sponsored enterprises (GSEs) have gained market share largely by default. As the "private-label" market for securitized subprime debt has collapsed, practically all that's left is Fannie and Freddie's business -- packaging and reselling far less risky mortgages. Still, it's remarkable that these twin giants now issue two-thirds of all mortgage-backed securities, up from 48.9 percent in the second quarter of 2007. Their total exposure is about $4.8 trillion.

What the GSEs don't have, however, is a regulator with authority and independence commensurate to their importance in the U.S. economy. Though owned by private shareholders, Fannie and Freddie benefit from an implicit guarantee that the federal government will bail them out of any serious financial crisis, which makes sound regulation all the more important. The market's assumption that Uncle Sam stands behind the GSEs means that private credit rating agencies do not penalize them for risky practices as they do other firms (at least in theory). And the accounting scandals at both enterprises in recent years showed that the government agency responsible for preventing threats to their safety and soundness was not quite up to the task. That agency, the Office of Federal Housing Enterprise Oversight (OFHEO), has been doing a better job lately. Fannie and Freddie are working under agreements with OFHEO that restricted their holdings and required them to increase capital. But the regulator lacks key statutory tools, such as the power to set capital requirements for the GSEs or its own authority to litigate; OFHEO must rely on Justice Department lawyers. Nor does OFHEO have a budget of its own; its annual expenditures are hostage to the larger appropriations process for the Department of Housing and Urban Development.

Last May, the House of Representatives passed a bill that would remedy this situation. The legislation would replace OFHEO with a new, independent Federal Housing Finance Agency, which would regulate not only Fannie and Freddie but also the 12 regional Federal Home Loan Banks. The Senate, however, has done exactly nothing since then. Its inaction has been due in part to differences on other points of the bill between Republicans and Democrats -- and in part to the fact that the Senate Banking Committee chairman, Christopher J. Dodd (D-Conn.), was pursuing his long-shot presidential campaign. In recent weeks, both President Bush and Rep. Barney Frank (D-Mass.), who shepherded the House bill, have called on the Senate to get busy. It's not often that George W. Bush and Barney Frank agree on anything. In this case, they are both right.