Mortgage Giants' Revamp Disputed
White House Plays Down Reports of Creating 'Bad Bank' for Toxic Loans

By David Cho and Zachary A. Goldfarb
Washington Post Staff Writers
Friday, August 7, 2009

The White House on Thursday played down internal discussions of creating a government-backed "bad bank" to take hundreds of billions of dollars in troubled loans off the books of mortgage-finance giants Fannie Mae and Freddie Mac.

"The story out today is light years ahead of any decision-making process here," White House Press Secretary Robert Gibbs told reporters, referring to a story Thursday in The Washington Post. "Safe to say that many senior administration economic officials learned of this proposal sometime this morning at the foot of their driveway."

But an e-mail, dated Wednesday, between the Treasury Department and the White House's National Economic Council said that the bad bank approach has been the subject of policy papers distributed across the administration.

The idea was "part of the agenda for discussion circulated by NEC and it has appeared in several internal papers written on this topic," the e-mail said.

The e-mail was written by an administration official involved in the Fannie and Freddie discussions and was crafted to inform NEC officials about the state of the discussions after the White House and Treasury received questions about the proposal from reporters.

That proposal, one of several under consideration, calls for placing the bad debts that Fannie Mae and Freddie Mac own in new, federally guaranteed financial institutions -- or bad banks -- that would take responsibility for collecting as much of the outstanding balance as possible and put the government on the hook for any losses.

The e-mail was provided to The Post by a source on the condition that neither the source nor the author be identified because the communications were private. It said that the Fannie and Freddie reform process "being run by the NEC started this week" and "is very wide in terms of interagency (HUD, FHFA, OMB, Treasury), it is not surprising that pieces are leaking."

The author told NEC officials in the Wednesday e-mail that sending a "stern message . . . at the beginning of tomorrow's meeting is probably warranted on process integrity."

Other government sources confirmed that meetings are being held this week to address Fannie Mae and Freddie Mac. They declined to speak publicly because they were not authorized to do so.

In his news briefing, Gibbs told reporters that "there's no meeting that's scheduled" for Thursday.

In response to questions about the e-mail, White House spokeswoman Jennifer Psaki said in a statement that an "organizational meeting" was planned for Thursday, but was cancelled "due to scheduling conflicts." Two other "preliminary" meetings have taken place, but top officials such as Treasury Secretary Timothy F. Geithner and NEC Director Lawrence H. Summers have not yet been included, she said.

Psaki noted that the administration laid out a half-dozen options for restructuring Fannie and Freddie in a regulatory reform plan that was rolled out in June. Though that plan did not mention the idea of the bad bank, such a proposal is one of many being considered, she said.

"The facts are that no proposal has been taken up by the NEC and no meeting has been held to discuss specific reform options," Psaki said. "The notion that any specific option such as good bank, bad bank has gained any momentum is erroneous."

Other government officials and lawmakers, including Fannie and Freddie's outgoing chief regulator James B. Lockhart III, confirmed that the administration is discussing the idea of the bad bank, but they said that any decision about the future shape of the two firms might not come until next year.

How the government handles the restructuring of District-based Fannie Mae and Freddie Mac, based in McLean, is of critical importance. With the private market for mortgage financing all but gone as a result of the financial crisis, the two companies have become practically the sole providers of mortgage financing in the country.

The two companies have government charters to buy home loans from banks, which they then repackage and sell to investors. The banks can then use the proceeds to offer more loans to home buyers.

Numerous analysts and government officials have noted that without Fannie Mae and Freddie Mac, and the government's backing of them, interest rates on home loans would have skyrocketed. Since the fall, the Treasury and Federal Reserve have been buying hundreds of billions of mortgage-backed securities to bolster the market.

Yet the companies are still struggling. Fannie Mae said Thursday that it lost $14.8 billion between April and June, compared with a $2.3 billion loss a year earlier. The second-quarter loss created a huge hole in the company's balance sheet and automatically prompts a $10.7 billion cash infusion from the Treasury on top of the $85 billion in direct aid that Fannie and Freddie have already received.

Together the companies have reported more than $150 billion in losses in the past two years.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said the idea of a "good bank, bad bank" is "one of the options that's being kicked around" for Fannie Mae and Freddie Mac's future. But he said that's just the starting point.

"The good bank, bad bank is how you deal with the transition, but at the same time, you decide what you do going forward," he said.

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