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GAO Analysis Skeptical About Privatization of Fannie Mae and Freddie Mac

By Jody Shenn
Bloomberg News
Friday, September 11, 2009

Privatizing Fannie Mae and Freddie Mac, the mortgage-finance companies seized by U.S. regulators last year, may be too difficult given the precedent set by the Treasury Department's financial assistance, according to a Government Accountability Office analysis.

"The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency," the GAO said in a report released Thursday. "Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets' perceptions."

The Treasury reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year. The companies, which own or guarantee about $5.4 trillion in U.S. residential debt and have accounted for about 70 percent of all new home loans this year, would need a "potentially lengthy transition" given their size, the GAO said.

The GAO, the investigative arm of Congress, provided a 66-page analysis of three main options for restructuring Fannie Mae and Freddie Mac: privatizing or eliminating the companies; turning them into government agencies; or reestablishing their structures as shareholder-owned, government-sponsored enterprises.

The GAO does not make recommendations on the best course of action, and it cites drawbacks to every option the report explores, as well as steps that could be taken to deal with those problems. The GAO noted that Federal Reserve Chairman Ben S. Bernanke has said privatization proposals that involve breaking the companies into smaller firms might help "eliminate the perception of federal guarantees."

Freddie Mac spokeswoman Sharon McHale and Fannie Mae spokesman Brian Faith declined to comment.

The companies' regulator, the Federal Housing Finance Agency, said the report does "a good job of summarizing the dominant proposals for restructuring the enterprises and assessing some of their strengths and weaknesses." The response was made in an August letter from then-FHFA Director James B. Lockhart III that was included with the report.

The government has committed as much as $400 billion to keep Fannie Mae and Freddie Mac afloat after regulators seized them amid mounting losses in September 2008 to protect holders of the companies' debt and mortgage bonds. Restructuring options discussed have included turning Fannie Mae and Freddie Mac into public utilities, liquidation or separating the companies into a "good bank" of strong assets and a "bad bank" of weak ones.

Drawbacks of turning Fannie Mae and Freddie Mac into government agencies include the companies having to "face greater challenges than private-sector entities in obtaining the human and technological resources necessary to manage complex processes or lack the operational flexibility to do so," the GAO said. That might result "in substantial taxpayer losses."

The companies have booked a combined $165.3 billion in net losses over the past two years and have received or requested $95.6 billion in taxpayer aid since November.

Creating "reconstituted" for-profit government-sponsored enterprises, either publicly traded or owned by lenders, "could lead to even greater moral hazard," the agency said. Making them public utilities "could, in principle, constrain excessive risk-taking, but the applicability of the public utility model of regulation to the enterprises has not been established."

Most proposals for leaving the firms as government-sponsored enterprises envision them having smaller portfolios or none at all, with similar drawbacks to the option of becoming federal agencies, the GAO said.

Eliminating Fannie Mae and Freddie Mac completely may simply leave some mortgage lenders as the "too big too fail" entities, according to the report. There also "is significant reason to question the capacity of private banks to support mortgage markets in times of financial distress without government support," after their recent retreat, GAO said.

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