The Help Fannie and Freddie Need
Don't bail out Fannie Mae and Freddie Mac. They don't need it. The losses they face are not surprising, given what's happened to housing prices. They have more than enough capital to meet their cash obligations when those become due, which is the most basic definition of solvency. They also have hundreds of billions of dollars' worth of unencumbered assets that can be used as collateral for secured borrowing, were that to become necessary. The recent Treasury proposals do not change these facts.
What the companies need from Washington is policy clarity. I say this not just on the basis of my experience as an executive at Fannie Mae but also because of my experience as director of the Office of Management and Budget and my time as an investment banker in the 1980s, when I helped solve the problems of cities and states in financial crisis.
The Treasury proposals, curiously, substitute government capital for private capital. Fannie and Freddie have served their housing mission for decades by marshalling private equity from around the world. Federal capital funds are inherently limited, while private capital is essentially unlimited. The goal of any rescue plan should be to restore unfettered access to the private markets.
The administration and Congress need to recodify the basic understanding between the two companies and the capital markets that has worked so well for so long. While recent efforts have quelled short-term concerns about an imminent collapse, we should be focused on what's needed for the longer term.
Here are a few sentences for policymakers to start with:
Fannie Mae and Freddie Mac remain and will continue to be integral parts of the U.S. housing finance system. Their central role in housing policy, not a federal guarantee, is what has attracted trillions of dollars of debt capital.
This would not be an easy statement for the White House or the Fed to make. It would require them to abandon their multiyear effort to eliminate the companies by talking them down to the financial markets. Buyers of long-term debt are not interested in investing in entities that are opposed by their national government or are slated for extinction. Treasury Secretary Henry Paulson appears to be trying to make such a declaration, but the silence from the Fed and the White House on whether the companies have a future is deafening.
Fannie and Freddie will be permitted to operate as for-profit companies able to earn a competitive return on invested equity capital.
It has been confusing, at best, for equity investors to hear officials call for Freddie and Fannie to raise more capital while simultaneously restricting their ability to earn a profit on that capital. The government needs to remove impediments to the companies' investing in on-balance-sheet assets, creating new products within the secondary mortgage market and managing risks in the most cost-effective manner. Also, Congress needs to make clear that the companies are not going to be a cookie jar to be raided whenever housing funds are needed elsewhere. If Fannie and Freddie can earn a competitive return on capital invested, there will be no limit to the amount of equity capital they can raise.
Congress should make clear that the requirements imposed on Fannie and Freddie regarding the capital they must have on hand will be based solely on the amount needed to support the risks they take. Many in the market fear that a new regulator, as contemplated in pending legislation, would use capital requirements as a way to restrain the companies' growth or limit the scope of their activities in the secondary market. Injecting the Fed into the capital regulatory process does nothing to assuage this fear.
Fannie and Freddie can borrow from the Federal Reserve on a fully collateralized basis in the same manner as any bank in America.
The Fed has acknowledged the need for such access on a temporary basis. Congress needs to make that access permanent.
It is ironic that the administration is straining to convince the financial markets that the U.S. government stands behind the two companies. That was the market view seven years ago. However, ideologues in the Bush administration and commercial competitors of Fannie and Freddie have skillfully manipulated the markets to undermine Fannie and Freddie for more than six years. The result has been a weakening of the two linchpins of the housing finance system just when they are needed most.
Just yesterday, Fed Chairman Ben Bernanke outlined the problems facing our economy. It is time to make a choice: Continue the policy approach of trying to kill off the companies and reap the economic carnage that will inevitably produce, or make a forthright statement that these companies are necessary instruments of national policy. Paulson has tried to move the administration and the Fed back from the brink. But too much ambiguity remains.
President Bush should stand with Secretary Paulson, Chairman Bernanke, Fannie and Freddie's regulator, and with the chairmen of the relevant House and Senate committees, and together they should declare Fannie and Freddie's clear roles in our markets. They should codify this role in legislation that will bind future administrations. The sooner this happens, the better.
The writer was chairman and chief executive of Fannie Mae from 1999 to 2004 and served as director of the Office of Management and Budget in the Clinton administration. He receives a pension and deferred compensation from Fannie Mae and owns stock in the company.