This is the third and last conference on two complementary plans for the privatization of Fannie Mae, Freddie Mac and the Federal Home Loan Banks, and the creation of a new more competitive and more efficient system for financing housing in the United States. As a result of the comments received at two prior conferences, and from others who have contacted Bert, Tom and me offline, the plans have been revised. Copies of the revised plans are in your folders.
The comments we receive at this conference will be used to make further revisions in the plans. Then we will proceed to the drafting of legislation.
Fannie and Freddie, meanwhile, have had another tough week.
- As reported by the American Banker, White House sources indicated that the President would not reappoint the five directors of Freddie that he is entitled to appoint under Freddie’s charter, and will leave the places on Freddie’s board vacant. Presumably, the same thing will be done when Fannie’s annual meeting is scheduled. This provides some much needed separation between the administration and these two companies, and is a clear step in the direction of privatization.
- OFHEO imposed a 30 percent capital surcharge on Freddie Mac, to remain in place until its accounting problems are corrected.
- Congress voted to increase the funding of OFHEO by $7.5 million for the current fiscal year, so that the agency could hire forensic accountants to review Fannie’s accounting. Forensic accountants, for those who do not know, look for accounting tricks that hide losses.
- Fannie Mae refused to provide Senator Hagel with quarterly fair value data, or information about what losses Fannie might have suffered in closing out losing derivatives positions during 2003. Senator Hagel called Fannie’s responses “incomplete,” and said that it strengthened his view that the company needs a tougher regulator.
- HUD, for the first time, announced that it would seek authority to assess Fannie and Freddie a total of $6.25 million to support better enforcement of HUD’s affordable and low income housing goals.
- Fannie had to threaten members of Congress with criminal action and having to deal with Kenneth Starr if they released information provided by OFHEO that disclosed the compensation of Fannie’s top 22 officials. Representative Jan Schakowski, a Democrat and the ranking member on the House Commerce Subcommittee on Consumer Protection, said “I think the public has a right to see it,” and Cliff Stearns the subcommittee chair said, referring to Fannie, “if they want all the advantages of being secret, then they should be private corporations.”
- Stories kept appearing about the skiing boondoggle Fannie has offered to 75 Congressional staff members--a February weekend in the Deer Valley resort in Utah after Senator Bennett’s conference. These stories regularly tied the offer to the forthcoming congressional action on enhanced regulation of Fannie and Freddie, cynically suggesting that the two were related.
Finally, this past Monday, OMB released its budget analysis, which spent a considerable amount of time on Fannie and Freddie. Among the things that OMB had to say were the following:
- “The GSEs are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions. A consequence of that highly leveraged condition is that a misjudgment or unexpected economic event could quickly deplete this capital, potentially making it difficult for a GSE to meet its debt obligations. Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy.
- OMB reiterated the administration’s support for a new regulator, but reaffirmed administration support for several items that Fannie Mae has made clear are unacceptable:
- Receivership authority
- “Authority to review ongoing business activities and reject new ones proposed by the GSEs, if they would be inconsistent with the charter or prudential operations of the GSEs, or incompatible with the public interest.” This is a far broader test than simple compatibility with the GSEs’ charters.
- Authority to set capital requirements: “It is essential that that the new regulator of the housing GSEs have ongoing authority to adjust both risk-based and minimum capital requirements.” Again, this would be authority that could, if exercised, directly affect earnings by reducing leverage.
Accompanying this portion of the OMB analysis was the attached table, showing the capitalization of Fannie and Freddie in relation to other large financial institutions.
- In addition, noting that Fannie and Freddie only lower mortgage rates by 25 basis points--and that some studies show even smaller reductions--OMB expressed dissatisfaction with this level of support for the market: “One reason interest rates are not lower is that Fannie Mae and Freddie Mac do not pass through the entire subsidy to mortgage borrowers. According to CBO, 37 percent is retained by the companies, their executives, their shareholders, or other stakeholders. Current market and regulatory mechanisms are not sufficient to force the GSEs to pass on greater savings to borrowers.” The implication is that the administration would welcome action--regulatory or otherwise--that would force Fannie and Freddie to give up more of their subsidy to the market.
- Finally, the OMB analysis noted that Fannie and Freddie lag the market in providing low income and affordable housing: “HUD has conducted analyses showing that private lenders operating without the benefits and subsidies enjoyed by the GSEs contribute more to affordable housing than do Fannie Mae and Freddie Mac.”
Given the pressures that are building against them, it would be surprising if Fannie and Freddie were not giving some thought to privatization themselves at this point.
This could well make business sense. Five years ago, Sallie Mae, which had privatized in the mid-1990s, was selling at approximately $10 per share; today it’s near $40 per share. In contrast, five years ago Fannie Mae was selling at about $72. Today, it’s selling at $77. And this after double-digit increases in profitability for every year in the last five.
This suggests that investors are worried about Fannie’s continued ability to manage its political risk--something that has not been in question for many years. The items noted above are examples of why investors are concerned, and it might be time for the managements of Fannie and Freddie to consider privatization seriously.
If they do, we’ll have just the plan . . . and it’s free!
Peter J. Wallison is a resident fellow at AEI.
