Risks Seen for Growing Fannie, Freddie

Saturday, March 1, 2008 6:52 AM

WASHINGTON -- Loosening the regulatory reins around Fannie Mae and Freddie Mac gives them the freedom to play a bigger role in trying to stabilize a worsening housing market.

The danger, some analysts say, is that the government-sponsored mortgage titans will become saddled with too much financial risk.

Fannie and Freddie this week reported fourth-quarter losses totaling $6.1 billion and predicted multibillion-dollar losses throughout 2008. Yet despite their financial troubles and the shakiness of the U.S. housing market, the government is making it easier for Fannie and Freddie to take on additional home-loan debt, something the companies have sought for months.

First they won the right - as part of a bipartisan economic stimulus package - to buy and guarantee mortgages above the traditional $417,000 limit. Then - as a reward for filing timely financial statements following multibillion-dollar accounting scandals - the companies were freed of a combined $1.5 trillion cap on their mortgage-investment holdings. Their regulator also raised the possibility of relaxing a mandated capital cushion Fannie and Freddie must keep in reserve.

While members of Congress and the Bush administration are hopeful these changes will enable Fannie and Freddie to help stem the housing downturn, some financial experts believe it is irresponsible to encourage the No. 1 and No. 2 mortgage finance companies to grow at this point in time.

Asked about the potential risks from being allowed to expand, the companies point to their mortgage portfolios currently being tens of billions below the now-expiring $746 billion limit. Without an easing of the risk capital level, they say, it is difficult for them to purchase as many mortgages as desirable to help the market.

"We have consistently shown that we operate in a very safe and prudent manner," said Freddie spokeswoman Sharon McHale. Fannie spokeswoman Amy Bonitatibus declined to comment.

Nobody is suggesting that Fannie and Freddie are on the verge of failure anytime soon. Some on Wall Street are even cheering the companies' efforts to gain market share at a time when smaller lenders are retreating.

That said, there is concern among some experts that they have grown too large and could endanger the financial system if they were to totter or fail.

"Neither of these organizations has enough capital to cover their risk, and they know it," said Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics, a firm based in Torrance, Calif. "I'm concerned about solvency for these entities."

Congress created Fannie during the Depression and Freddie in 1970 to keep money flowing into the home-loan market by buying up mortgages and bundling them into securities for sale to investors worldwide - thereby making home ownership affordable for low- and middle-income Americans.

Today the companies hold or guarantee around $4.9 trillion in home-loan debt, though under a 1992 law they are required to hold in reserve against risk only a fraction of what is mandated for commercial banks.

While the Treasury Department isn't obligated to assist Fannie or Freddie in a financial emergency, there is a perceived notion on Wall Street that the government would bail them out in the event of a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply on global markets by issuing hundreds of billions of dollars in top-rated securities backed by mortgages.

This implicit government backing worries some analysts.

"Fannie and Freddie are really, really big. These recent changes make them even bigger," said Joseph Mason, a finance professor at Drexel University in Philadelphia. "At some point they become too big to save."

Rating agency Moody's Investors Service this week said it may lower its assessment of Fannie's financial strength - a rating that measures the likelihood that a financial institution will require assistance from an outside party such as shareholders or the government.

For now Fannie and Freddie likely will operate - even with the freed-up portfolios - largely as packagers and resellers of mortgage securities as opposed to holding them in the portfolios, analysts say. That business helps provide funding to prospective home buyers and generates tidy fees for the companies.

The director of the Office of Federal Housing Enterprise Oversight, James B. Lockhart, said this week that the agency will discuss with Fannie and Freddie executives "the gradual decreasing" of the 30 percent capital cushion they must hold in reserve against risk.

The restriction means Fannie and Freddie must put billions into reserve as capital that they otherwise would be able to use to buy more mortgages.

For critics, freeing up more capital for the companies' investment portfolios would make them more dangerous.

"We should be increasing their capital requirement, not loosening it," Sen. Chuck Hagel, R-Neb., said in a statement.

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