Curbing Fannie and Freddie

On the spectrum ranging from bureaucratic to entrepreneurial agencies, Fannie Mae and Freddie Mac-congressionally chartered corporations established to make mortgages more affordable-are almost off the charts on the businesslike end. And while Capitol Hill rhetoric prods agencies to adopt private-sector practices, the blurry line between business and government in the case of Fannie Mae and Freddie Mac has been the subject of recent debate.

With huge marketing budgets, hundreds of thousands of shareholders and high profits, the mortgage behemoths look and act more like businesses than government agencies.

But Fannie and Freddie also exhibit public-sector traits. They have a line of credit at the U.S. Treasury. They don't pay state and local taxes (except property taxes). They aren't subject to standard corporate disclosure, antitrust or insider-trading laws. They must meet goals set by the Department of Housing and Urban Development for expanding low- and moderate-income housing and reaching underserved areas.

Questions about where, exactly, Fannie and Freddie fit into the taxonomy of businesses and government agencies are of special interest to the financial markets. Despite disclaimers, Wall Street stubbornly behaves as though investments in Fannie and Freddie are backed by the government, a belief supported by the fact that Fannie received federal tax relief in the early 1980s when steep interest rates threatened its stability.

The problem, say Treasury Secretary John Snow and Federal Reserve Chairman Alan Greenspan, is that this belief buffers Fannie and Freddie from market scrutiny. "The existence, or even the perception, of government backing undermines the effectiveness of market discipline," Greenspan testified before the Senate Committee on Banking, Housing and Urban Affairs in mid-March.

Snow and Greenspan issued frightening warnings that Fannie and Freddie could fail. Together, the giants have issued about $1.6 trillion in debt-almost one quarter of the national debt. They're so big, some say, that if they were to falter, they could take the rest of the economy down with them. Fannie Mae CEO Franklin Raines insists the chance of failure is negligible.

To resolve the quandary posed by Fannie and Freddie's public-private status, the Senate Banking Committee passed a bill on April 1 that would create an independent regulator. The plan gives the new agency the power of receivership, meaning it could liquidate the corporations' assets and shut them down if they became insolvent.

Like an indulgent parent's early attempt to shoo a grown child out of the house, the bill is a gentle move. It doesn't rule out a federal bailout, but hints that the corporations don't have as much support as Wall Street believes. "It's more a symbolic act," says Lawrence White, a professor at New York University and a former Freddie Mac director. "The financial markets treat [Fannie and Freddie] as special. I think it is one small step toward making them a little less special."

Executives from the two corporations expressed concern about the bill's potential to unsettle markets, but investors don't seem rattled. Shortly after the bill was released, Moody's Investors Service told investors the proposal won't affect its rating for Fannie and Freddie. "Moody's does not believe that this bill will reduce, sever or otherwise materially change the diverse and important ties" between the government and the corporations, John Kriz, managing director of the real estate finance group, said in a statement shortly after the bill was proposed.

The bill lacks the momentum to make it to the Senate floor this year, anyway. The White House opposes it because of an amendment that softens the receivership provision. Many Democrats don't want the regulator to have receivership powers at all.

Even Senate Banking Committee Chairman Richard Shelby, R-Ala., denounced the bill immediately after his committee approved it. "Clearly," he said, "the Congress needs to do more work on this issue. "