Fannie, Freddie Cleared To Buy More Mortgages

By David S. Hilzenrath
Washington Post Staff Writer
Thursday, March 20, 2008

The federal government yesterday gave Fannie Mae and Freddie Mac permission to operate with a reduced safety net in order to increase their aid to the troubled mortgage market.

The step could allow the two federally chartered finance companies to immediately increase their investment in mortgages by a combined $200 billion, potentially compensating for weak demand from other investors. That could improve the availability and affordability of home loans, leaders of the two companies said.

Together, the two companies already hold more than $1.4 trillion of mortgages and securities backed by mortgages.

Yesterday's decision by the Office of Federal Housing Enterprise Oversight reduces the amount of capital that Fannie Mae and Freddie Mac are required to hold as a cushion against losses.

OFHEO Director James B. Lockhart III dismissed as "nonsense" speculation that one or both of the companies could require a bailout. Both companies are financially safe and sound, he said at a news conference. In a statement, he pledged to supervise them with vigilance and "act quickly to address any deficiencies that may arise."

As the market has deteriorated, the companies have lost billions of dollars, and they are predicting their losses from defaults and foreclosures will continue. Freddie Mac temporarily fell below its capital requirement in November. Yesterday's announcement "should help restore confidence in the market," Lockhart said in an interview.

The action represented a shift in regulators' posture toward Fannie Mae and Freddie Mac, underscoring the severity of the mortgage crisis and the pressure on government officials to do something about it.

In the seemingly healthy market before the housing bubble burst, regulators were warning that Fannie Mae and Freddie Mac were taking on so much risk that they posed a potential hazard to the financial system.

As recently as last month, Lockhart said that any easing of the capital requirements should be coupled with passage of long-stalled legislation that would overhaul regulation of the companies, both of which spent years recovering from multibillion-dollar accounting scandals.

Sen. Charles E. Schumer (D-N.Y.), a major ally of the companies, called for other conditions.

"Any capital relief has to come with a substantial new commitment [by Fannie Mae and Freddie Mac] to purchase loans for struggling subprime borrowers," Schumer said at a February hearing. "If Fannie and Freddie won't enter this agreement voluntarily, we should consider imposing it as part of the agreement to lift the capital surcharge."

In the aftermath of the accounting scandals, OFHEO made use of its limited oversight powers to extract agreements from Fannie Mae and Freddie Mac that they would maintain 30 percent more capital than normally required. Yesterday, OFHEO said it is reducing that 30 percent surplus requirement to 20 percent and will consider further reductions.

The capital requirement is meant to ensure that each company has sufficient resources to meet its obligations. Fannie Mae's capital requirement was reduced to $38.3 billion from $41.5 billion, and Freddie Mac's was reduced to $31.8 billion from $34.4 billion.

The combined reduction of about $5.9 billion would allow Fannie Mae and Freddie Mac to increase their mortgage investments by about $200 billion because they are allowed to operate with what some policymakers describe as relatively thin cushions.

Even with the extra 30 percent, the two companies were highly leveraged and inadequately capitalized, said Karen Shaw Petrou, managing partner of the consulting firm Federal Financial Analytics.

"I think these are desperate times that drive policymakers to do things they don't want to do because of the fragile nature of the financial system as a whole," Petrou said.

Chartered by the government to keep the housing finance system functioning smoothly, Fannie Mae and Freddie Mac buy mortgages from lenders, giving lenders funds to make more loans. Fannie Mae and Freddie Mac also package mortgages into securities for sale to other investors, promising to make the payments if the borrowers default. The publicly traded companies benefit from the widespread perception that the government would meet their obligations if either became insolvent.

The discussions that led to yesterday's action included the Treasury Department and the Federal Reserve, institutions that are usually focused on reining in the companies.

Though relaxing the capital requirement was one of the government's main sources of leverage over the companies in ongoing policy disputes, the announcement was not accompanied by any written agreements with Fannie Mae and Freddie Mac, and the firms are not explicitly obliged to invest their increased capacity in any particular way.

The companies promised to raise additional capital from investors, but they did not spell out how much money they will raise or when they will raise it.

A source familiar with the negotiations, who was not authorized to speak for the record, said the companies agreed to raise capital in amounts equal to the reduction in their capital requirements.

Lockhart gave a different account in an interview, saying that the amount the companies raise will be "significant," but that "we haven't agreed to any numbers."

In a news release, OFHEO said the companies "have renewed a shared commitment" to work for legislation reforming the way they are regulated.

The language about a renewed commitment was inserted at the end of the negotiating process and is not backed by any specific pledges that the companies will change their positions, according to the source.

Fannie Mae and Freddie Mac have long expressed general support for reform while lobbying against provisions that regulators consider important.

News of a possible reduction in the capital requirement sent what had been deeply depressed shares of Fannie Mae and Freddie Mac soaring Tuesday by 27.1 percent and 26.2 percent, respectively. Yesterday, the stocks were up another 8.8 percent and 14.9 percent.

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