Modifying the Mortgage Giants
Fannie, Freddie Tilt From Profit Goals Toward Public Mission to Buoy Market

By Zachary A. Goldfarb
Washington Post Staff Writer
Monday, December 8, 2008

After the government announced last month that Fannie Mae and Freddie Mac would take new steps to modify tens of thousands of mortgages to make them more affordable, some executives expressed concerns that the moves could weaken their already struggling companies.

Fannie Mae's chief executive, Herbert M. Allison Jr., acknowledged these fears in a staffwide message. "As we take further steps to aid homeowners, some employees are asking about the potential cost to the company of modifying loans to help distressed borrowers," he wrote. "Our challenge is to keep families in their homes and support the mortgage markets."

In the long-running contest between profits and public policy at Fannie and Freddie, public policy is winning.

Fannie and Freddie have always had to strike a balance between the imperative of profit-maximizing, shareholder-owned institutions and the public mission of firms charged with ensuring affordable housing. But since the government seized the firms in early September, the balance has shifted.

"We're tilting toward the public mission of the company to safeguard homeowners," Allison said in an interview.

Last week, sources said the Treasury Department was strongly considering a plan to use Fannie Mae and Freddie Mac to dramatically force down what Americans pay for home loans. The plan would require that Fannie and Freddie buy 30-year, fixed-rate mortgages if they have a 4.5 percent interest rate, the lowest in history. In turn, the Treasury would purchase these loans from the companies.

Allison, Freddie chief executive David M. Moffett and the federal regulator who hired them, James B. Lockhart III, must walk a fine line. Taking steps to support the housing market and help borrowers could cost the firms, depriving them of revenue and forcing them to assume even riskier investments. And the Treasury has put taxpayer money on the line for up to $200 billion in losses at the companies.

But doing too little could delay a housing recovery as more homes fall into foreclosure and people have trouble getting home loans. That could also hurt the bottom line. "If housing prices continue to fall, losses will mount at Fannie and Freddie," Lockhart said. "There's no doubt that the sooner we can get stability to the mortgage market, the better off they will be."

There are other questions -- for instance whether the companies will eventually resume their traditional rivalry as private enterprises or remain under government control indefinitely. The unusual hybrid nature of Fannie Mae and Freddie Mac dates back 40 years when they were chartered by Congress to supply financing to the mortgage market and support affordable housing.

With the government still insisting that the firms pursue both a public policy agenda and profitability, executives have yet to resolve how far they should tilt toward the former. Using identical language, the companies said in recent financial disclosures that the various goals "create conflicts in strategic and day-to-day decision making that will likely lead to less than optimal outcomes for one or more, or possibly all, of these objectives."

In the past three months, Fannie and Freddie have announced they are modifying tens of thousands of mortgages, suspending foreclosures and evictions during the holiday season, canceling fees to back home loans and expanding their purchases of mortgages and mortgage-backed securities.

The moves are in part a reversal of what Fannie and Freddie were doing before being taken over. This summer, the companies were raising fees and buying fewer mortgages with the goal of conserving cash and building up their financial cushion to withstand billions in losses in the mortgage market meltdown.

More broadly, in the latter years of the housing boom, Fannie and Freddie often put shareholder profit first, moving into riskier areas of the mortgage business in search of higher returns.

Within weeks of the government's takeover, several senior executives at both firms left as the new chief executives installed their own teams. More recently, Freddie's treasurer, Timothy Bitsberger, who, a source said, privately argued that the company shouldn't expand its portfolio of mortgages in the face of a collapsing market, resigned. Bitsberger, a former Treasury official and Wall Street trader, declined to comment.

Other executives with experience in the mortgage market would also like to leave because the companies are no longer the high-flying finance houses they once were, according to current and former executives. But these senior employees are staying because the companies have put in place cash retention programs and there are no jobs to be had on Wall Street.

One source of tension inside the firms was the decision by their new chief executives to cancel a planned increase in the fees that Fannie and Freddie charge when they buy mortgages from lenders, bundle them, guarantee them against default and then sell them to investors. The fees would have been passed on to borrowers, increasing the cost of home loans. Some at Fannie and Freddie argued the fees were necessary given the losses the companies were facing.

"They were thinking about it from an economic standpoint. They made a strong case that it would maximize their profits," Lockhart said. "On the other hand it would have been the wrong thing to do for housing market."

Lockhart urged that the fee increase be canceled, and the companies ultimately closed ranks around this position.

What the companies ought to be doing under government control has at times been perplexing. Initially, the Treasury tapped Fannie and Freddie to help run a program buying troubled assets from banks and other financial firms, according to two people familiar with the matter. Then, the Treasury abandoned the effort in favor of injecting capital into banks.

No initiative has been more illustrative of the shift at the companies than their efforts to prevent foreclosures. When the government took over Fannie and Freddie, neither Lockhart nor Treasury Secretary Henry M. Paulson Jr. mentioned combating foreclosures as a goal.

At the time, the government wanted Fannie and Freddie to pump cash into the mortgage market with the hope of reducing interest rates. The accelerating crisis in the financial markets this fall made that very difficult by undermining Fannie and Freddie's efforts to obtain affordable financing.

Last week, in an acknowledgment that Fannie and Freddie couldn't fix the home loan market by themselves, the Treasury and Federal Reserve announced a $500 billion program to buy mortgages, which has already helped lower mortgage interest rates.

Weeks before that announcement, with the firms' efforts to buy mortgages running into trouble because of the financial crisis, Fannie and Freddie's agenda was already focused on preventing foreclosures.

In mid-November, Lockhart made a high-profile announcement that Fannie and Freddie would establish a new program to modify mortgages. The program targets borrowers who are three months late on their payments. These borrowers would have their mortgages modified so that their monthly payment equals 38 percent of their income -- by extending the loan term to 40 years, reducing the interest rate and even delaying payment on part of the principal.

The program had critics inside and outside government. The Federal Deposit Insurance Corp.'s chairman, Sheila C. Bair, who has tussled with the Bush administration over her desire to use part of the government's bailout fund to modify mortgages, said at the time that Fannie and Freddie's plan "falls short of what is needed to achieve wide-scale modifications of distressed mortgages."

Bruce Marks, executive director of the Neighborhood Assistance Corporation of America, called the plan just "symbolism."

"Very few people will qualify," he said, "and the people who do qualify will pay such a high percentage of their income for their mortgage payments that they will have very little left for the basic necessities."

Marks held a protest with 100 people in October outside Fannie's Wisconsin Avenue headquarters, and Allison invited him inside, talking with him for an hour in the first of two meetings. Although critical, Marks credited Allison with being open-minded. "He was not afraid to ask the questions, to push the issue and to voice his opinion," Marks said.

In late November, Lockhart, Allison and Moffett made their first pilgrimage to the office of Rep. Barney Frank (D-Mass.), chairman of the influential House Financial Services Committee.

Frank, who had complained that the administration was not doing enough to help struggling borrowers, had invited the three men to learn how they would address foreclosures. Sitting side by side, Lockhart, Allison and Moffett explained what they were doing but added that other firms owned most of the country's distressed mortgages and needed to take big steps, too.

Fannie and Freddie are now considering additional steps, including reducing the amount of income applied toward a mortgage and modifying loans before they become delinquent, according to people familiar with the companies' plans. "We're not going to be bound by past policies, traditions and habits," Allison said. "And we're going to take a very open and unfettered look at how we're operating."