Bush re-election haunts Fannie and Freddie

November 12, 2004

Tough reform of housing enterprises may be in store

By Samantha Peterson
Inman News

Mortgage heavyweights Fannie Mae and Freddie Mac likely face tougher oversight reform proposals over the coming year in light of President Bush's re-election and Republican gains in both houses of Congress, according to industry observers.

Since the Freddie Mac accounting scandal rattled investors last year, Congressional members have crafted and discussed passing legislation to strengthen oversight of the housing government-sponsored enterprises, or GSEs. But Congress failed to pass any bills, slowed by lengthy debates on various details.

The stalemate scenario may be changing. Observers believe the Bush administration is ready to aggressively pursue GSE reform and that with more Republicans now in Congress, it has the political muscle to make those changes. Reform proposals likely will be more comprehensive and higher priority than they've been in the past.

"I think it's going to be the first bill out of the banking committee," said Jim Butera, partner with Butera & Andrews, a Washington, D.C., law firm that also lobbies in the mortgage and real estate arenas.

Peter Wallison, a resident fellow at the American Enterprise Institute, is confident the administration will press for reform. Whether Congress follows through remains to be seen, but Wallison believes the administration has laid the groundwork.

"The stars are more aligned now than they have been in a long time for getting legislation through," Wallison said. "The recent accounting problems at Fannie Mae have reduced a lot of the prestige the company has on the Hill. I think people are beginning to see both Fannie and Freddie as much weaker financially than they originally thought."

The Securities and Exchange Commission launched a formal investigation of Fannie Mae after the Office of Federal Housing Enterprise Oversight released a scathing 211-page report revealing evidence of improper accounting at the company. The company also has been the target of shareholder lawsuits and a Congressional hearing.

Lawrence J. White, economics professor at New York University's Stern School of Business, thinks Fannie and Freddie will face reform at the regulatory level. The current regulator, OFHEO, will probably be reorganized, moved out of its current home in the U.S. Department of Housing and Urban Development and into the U.S. Department of Treasury. Congress may grant the new regulator powers of receivership, which means it could shut down a GSE if it were in danger of insolvency.

The power of receivership concept tripped up legislators earlier this year in a reform push from Sen. Richard Shelby (R-Ala.). Butera doesn't believe receivership will stir as much debate this year. Instead, he said, reform proposals may go well beyond how the GSEs are regulated and venture into business issues such as what types of activities they can be involved in, their appropriate capital level and possible remedies in the event of a perceived deficiency.

In short, reforms put forth now will be broader and deeper than previous proposals, which Fannie and Freddie fought against. Wallison said he anticipates reforms that would take away some of the connections the GSEs have with government, tighten up the language about their missions and reduce both companies abilities to expand into other parts of the economy.

The challenge will be to create a tighter regulatory system without giving the impression that the companies are government wards, Wallison said.

OFHEO's ongoing investigation initially stemmed from the accounting scandal at Fannie's corporate cousin, Freddie Mac, which understated profits by about $5 billion for 2000-2002 to smooth earnings and meet Wall Street expectations. Freddie Mac paid a $125 million fine and ousted several top executives.

Both Fannie and Freddie are shareholder-owned but chartered by the U.S. Congress to maintain a constant flow of mortgage funds for the nation's housing market. The two corporations securitize and either resell or own a substantial portion of the outstanding home mortgage debt in the United States. The secondary market helps increase the liquidity of mortgage funds, making home loans more widely available.

The special GSE status includes numerous perks, such as discount-cost borrowing from the federal government and relief from SEC reporting requirements as well as local and state tax exemptions. A Congressional Budget Office report earlier this year estimated the government sponsorship of Fannie, Freddie and the Federal Home Loan Banks was worth about $23 billion in 2003.

Butera believes both Fannie and Freddie are probably ready to go through the reform process so they can escape headlines and return to normal business.

"Clearly the political landscape is challenging, but there is strong bipartisan consensus that our charter provides significant benefit to homeowners by lowering the costs of home ownership and making affordable housing a reality for more of America's families," said Sharon McHale, public relations director for Freddie Mac.

She said the company looks forward to working with Congress and the Bush administration, and is committed to having a strong, well-funded regulator.

A Fannie Mae spokesman did not return requests for comment.

On Election Day, Fannie Mae stock closed at $71.44; the next day it closed at $68.77. Freddie Mac's stock closed at $67.24 on Election Day; the next day it dropped to $65.99. Both stocks have edged up since then.

Copyright 2004 Inman News

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