Radical Options In Play for New Structure of Firms
Monday, September 8, 2008
Treasury Secretary Henry M. Paulson Jr.'s rescue plan for Fannie Mae and Freddie Mac almost certainly means the two mortgage financiers will cease to exist in their current form, igniting the battle over the future of these giant institutions.
Among top Treasury officials, there is increasing interest in structuring Fannie and Freddie like public utilities, according to sources familiar with Treasury's thinking. Under this model, the companies would be able to raise private money by issuing stock, but shareholder returns would be capped by regulators. This would be a new way of structuring the companies so they could maintain their public mission of supporting the mortgage markets without using public funding.
In contrast, GOP presidential candidate John McCain wants the firms downsized or simply closed, an economic adviser said. Campaign officials for Barack Obama said he thinks the status quo is "untenable" but hasn't taken a position on the ultimate form of the companies. They criticized McCain's stance as ideological and simplistic.
Any plan requires the approval of Congress, where sharp disagreements over whether Fannie and Freddie should be privatized, nationalized or maintained as a hybrid could take most of next year to resolve, according to several key lawmakers. Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee, and Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, say reforms must preserve the company's public role in making mortgages available and affordable. Many Republicans want to privatize the companies, exposing them to competition.
Until now, Paulson has been driving the debate. But he has flatly stated that he is departing in January, leaving the fates of the companies in the hands of the next Congress and the new administration.
Fannie Mae and Freddie Mac were created by the federal government to increase the supply and reduce the cost of mortgage loans. The companies borrow money at a relatively low cost because the government's involvement gives investors a sense of security. They use that money to buy loans from mortgage companies, allowing those companies to make more loans.
Democrats have long argued the companies deserve public support because they perform a crucial service: They make mortgages more available and affordable, particularly for lower-income families. Republicans say private companies could fill the same role, and that the government is basically subsidizing profits for the shareholders of the two companies.
In an interview, Paulson said it would be a "grave error" if Congress failed to decide the companies' future in the next year. He said the current hybrid structure -- under which Fannie and Freddie are expected to both support the mortgage market and make money -- would continue to pose a risk to financial markets.
"There are ambiguities and conflicts and structural flaws at the companies that don't do credit to our country," Paulson said. To prompt Congress to act, Treasury officials designed their rescue plan so that the firms will have to reduce their mortgage portfolio beginning in 2010 if lawmakers fail to reach a decision.
Paulson declined to say which idea he supported, adding that he would state his opinion in coming weeks. "It would be inappropriate for me to be advocating in this time a state or the ultimate model" for Fannie and Freddie, he said.
The rescue plan announced by Treasury yesterday put Fannie and Freddie under the control of the government. In the coming months, the firms will maintain their basic structure but will be managed more tightly, sources familiar with the matter said.
If the companies were eventually to be structured as public utilities, this would preserve the benefits of the hybrid model, which requires them to serve a public purpose without use of public funding. This would also eliminate a downside of this model by removing the possibility that shareholders receive the kind of windfall profits Fannie and Freddie posted during the housing boom. Management would have less freedom. The companies also would have less incentive to pursue innovations that might yield greater profits.