More Cash for Mortgages

Friday, March 21, 2008

TO UNDERSTAND Wednesday's decision by federal regulators to let Fannie Mae and Freddie Mac set aside less cash to protect against losses, imagine a family that keeps its precious antique silver in a strongbox on a high shelf, beyond easy reach. The regulators have essentially authorized Fannie and Freddie to pawn some of their family silver. Currently, the two firms, known as government-sponsored enterprises, or GSEs, have combined reserves of $82 billion. This includes an extra amount that the regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), required them to hold while they got their books in order after accounting scandals. Now it is reducing that extra cushion by $5.8 billion. The newly freed-up money will leverage the purchase and securitization of up to $200 billion in home loans.

The point, however, is not to save Fannie and Freddie themselves but to use the two firms, which buy mortgages and resell bunches of them to investors in the form of bonds, to ease the difficulties of borrowers more generally. It's as if our hypothetical family pawned its silver to help the neighbors out of a financial jam. Scouring the federal government's sphere of influence for every drop of cash that could improve liquidity for securities markets, the Federal Reserve Board and the Treasury Department have prevailed upon OFHEO to release some of Fannie and Freddie's pent-up capacity. The move is of a piece with other recent Fed actions, including its offer to accept Fannie and Freddie's mortgage-backed securities and other bonds as collateral for up to $200 billion in new loans to banks, and its decision to lend to investment banks.

This is risky. If all goes well, freeing up the GSEs will buoy mortgage lending, thus slowing or reversing the slide in housing prices -- which is at the root of the credit crunch. But if housing continues to tank, and the GSEs rack up new multibillion-dollar losses on top of those they have already incurred in recent months, they will have that much less in reserve to fall back on. The GSEs enjoy an implicit federal guarantee, but reducing their capital for a purpose such as this, at a time such as this, goes a fair way toward making that bailout promise an explicit one.

OFHEO says that GSEs are back on a sound financial footing and that the risks can be mitigated by Fannie and Freddie's promise of a "significant" voluntary increase in their capital. That promise must be kept. Even more important is for Congress to revamp and fortify OFHEO. The GSEs' regulator needs authority to set capital requirements commensurate with the GSEs' huge role in the mortgage markets and unique, quasi-governmental status. A bipartisan bill has been adopted by the House but has languished in the Senate. Strong reform of government-sponsored enterprises is vital to ensuring that the risks the firms have just been allowed to assume, in an emergency, will not threaten their safety and soundness -- or that of the wider economy.

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