Fannie and Freddie Need a Tougher Cop Watching Them: John Wasik
March 8 (Bloomberg) -- When Federal Reserve Chairman and free-market savant Alan Greenspan mentions ``systemic risk'' and the need for more regulation in one breath, millions of investors and legislators should be paying rapt attention.
Greenspan called for tougher regulation of the leviathans Fannie Mae and Freddie Mac, two shareholder-owned, government- sponsored enterprises (GSEs), that guarantee and package mortgage- based vehicles.
Together, the two entities have at least $1.6 trillion in assets, which makes them collectively larger than Citigroup, Inc., the biggest U.S. financial services company, with $1.2 trillion in assets.
Freddie and Fannie are the latest poster children for more regulation because few know the threat their mammoth portfolios pose to investors, especially in light of ambiguous government oversight and backing of those two enterprises.
If they defaulted on their debt in 2005, each taxpayer's burden in a bailout would be $16,434 according to an estimate posted on the Web site of FM Policy Focus, a Washington, D.C.- based group of financial associations that has called for stiffer regulation of the enterprises.
``Their trading in derivatives is a concern because they may not be properly hedged,'' said Michael House, executive director of the organization. ``It's a problem for the entire market.''
Independent Regulator Needed
While no one is predicting that the government-sponsored enterprises are in imminent financial danger, there are solid reasons for appointing a strong, independent regulator of the enterprises.
Speaking before the U.S. Senate Banking Committee Feb. 24, Greenspan said regulators ``must assess whether these institutions hold appropriate amounts of capital relative to the risks that they assume and the costs they might impose on others, including taxpayers, in the event of financial-market meltdown.''
Although investors generally believe that Fannie and Freddie are too big to fail -- and the federal government would back them with cash infusions -- there's no explicit guarantee akin to federal deposit insurance supporting the enterprises.
``All of these entities and their securities are exempt from the registration and disclosure provisions of the federal securities laws,'' said Alan Beller, the Security and Exchange Commission's director of corporate finance, before the Senate Banking committee on Feb. 10. ``None of the debt securities issued by any of these GSEs is backed by the full faith and credit of the U.S.''
Banks' Exposure
Despite the lack of ironclad government safeguards, highly regulated U.S. banks have a significant investment in Fannie and Freddie debt and mortgages.
``Federally insured institutions hold almost $300 billion, or roughly 17 percent, of the $1.8 trillion Fannie and Freddie direct obligations and almost $770 billion, or about 40 percent, or the $1.9 trillion mortgage pools,'' according to a March 1 report by the Federal Deposit Insurance Corporation, the government agency that insures bank deposits.
Due to the wide ownership of their securities, a GSE crisis would have a profound impact on millions of investors from huge pension funds to 401(k) participants.
For example, according to Bloomberg data, the largest holder of Fannie Mae stock is Boston-based Fidelity Investments, Inc., the largest U.S. mutual fund company by assets, through its largest mutual funds including Magellan, Puritan, Growth & Income and 60 other funds. As of Dec. 3, 2003, Fidelity held a total of nearly 78 million shares of Fannie Mae.
Poor Regulation
Capital Research & Management Co., the Los Angeles-based manager of the American Funds group, the best-selling U.S. mutual fund company and the third-largest fund group, was the largest single owner of Freddie Mac and the second-largest institutional holder of Fannie Mae.
As a matter of standing policy, both companies told me they would not comment on their holdings nor anything else connected with these stocks.
The government may not even know if there is a threat looming within Fannie or Freddie's portfolios because the entities are not subject to the same degree of disclosure and examination that public companies must provide their investors.
``They (the enterprises) haven't been regulated in the last 10 years,'' says Sean Egan, managing director of Egan Jones Ratings, Inc., of Haverford, Pennsylvania, an independent ratings service. ``Investors don't know the quality of their assets and their hedging. Their huge growth in assets and low growth in capital can't continue.''
Reform Needed
Egan's company rates Fannie Mae ``A'' (``AAA'' is the highest), because Fannie has only a 2 percent capital-to-assets ratio, a financial cushion measure, versus the 8 percent required for a regulated bank. ``That doesn't give us much comfort.''
Although they have resisted and lobbied against reform in the past, chief executives of Fannie and Freddie said they are willing to accept stronger regulation.
``We support legislation that would provide our regulator with full flexibility over our risk-adjusted capital requirement, since it is the regulator's premier tool to ensure we are well capitalized,'' said Franklin Raines, chairman of Fannie Mae before the Senate Banking Committee on Feb. 25.
Critics of the GSEs, though, caution that the debt levels of the enterprises are growing alarmingly fast under the perceived shield of government protection, which draws a painful comparison to the savings and loan crisis of the 1980s.
``It's a precedent,'' says Thomas Stanton, a Washington, D.C.-based lawyer who has called for more stringent GSE policing. ``They (the GSEs) haven't reduced their risk. It could've cost Congress $10 billion to clean up the S&Ls in 1981 if they had acted then. Instead it cost $150 billion when they finally acted in 1989.''
March 8 (Bloomberg) -- When Federal Reserve Chairman and free-market savant Alan Greenspan mentions ``systemic risk'' and the need for more regulation in one breath, millions of investors and legislators should be paying rapt attention.
Greenspan called for tougher regulation of the leviathans Fannie Mae and Freddie Mac, two shareholder-owned, government- sponsored enterprises (GSEs), that guarantee and package mortgage- based vehicles.
Together, the two entities have at least $1.6 trillion in assets, which makes them collectively larger than Citigroup, Inc., the biggest U.S. financial services company, with $1.2 trillion in assets.
Freddie and Fannie are the latest poster children for more regulation because few know the threat their mammoth portfolios pose to investors, especially in light of ambiguous government oversight and backing of those two enterprises.
If they defaulted on their debt in 2005, each taxpayer's burden in a bailout would be $16,434 according to an estimate posted on the Web site of FM Policy Focus, a Washington, D.C.- based group of financial associations that has called for stiffer regulation of the enterprises.
``Their trading in derivatives is a concern because they may not be properly hedged,'' said Michael House, executive director of the organization. ``It's a problem for the entire market.''
Independent Regulator Needed
While no one is predicting that the government-sponsored enterprises are in imminent financial danger, there are solid reasons for appointing a strong, independent regulator of the enterprises.
Speaking before the U.S. Senate Banking Committee Feb. 24, Greenspan said regulators ``must assess whether these institutions hold appropriate amounts of capital relative to the risks that they assume and the costs they might impose on others, including taxpayers, in the event of financial-market meltdown.''
Although investors generally believe that Fannie and Freddie are too big to fail -- and the federal government would back them with cash infusions -- there's no explicit guarantee akin to federal deposit insurance supporting the enterprises.
``All of these entities and their securities are exempt from the registration and disclosure provisions of the federal securities laws,'' said Alan Beller, the Security and Exchange Commission's director of corporate finance, before the Senate Banking committee on Feb. 10. ``None of the debt securities issued by any of these GSEs is backed by the full faith and credit of the U.S.''
Banks' Exposure
Despite the lack of ironclad government safeguards, highly regulated U.S. banks have a significant investment in Fannie and Freddie debt and mortgages.
``Federally insured institutions hold almost $300 billion, or roughly 17 percent, of the $1.8 trillion Fannie and Freddie direct obligations and almost $770 billion, or about 40 percent, or the $1.9 trillion mortgage pools,'' according to a March 1 report by the Federal Deposit Insurance Corporation, the government agency that insures bank deposits.
Due to the wide ownership of their securities, a GSE crisis would have a profound impact on millions of investors from huge pension funds to 401(k) participants.
For example, according to Bloomberg data, the largest holder of Fannie Mae stock is Boston-based Fidelity Investments, Inc., the largest U.S. mutual fund company by assets, through its largest mutual funds including Magellan, Puritan, Growth & Income and 60 other funds. As of Dec. 3, 2003, Fidelity held a total of nearly 78 million shares of Fannie Mae.
Poor Regulation
Capital Research & Management Co., the Los Angeles-based manager of the American Funds group, the best-selling U.S. mutual fund company and the third-largest fund group, was the largest single owner of Freddie Mac and the second-largest institutional holder of Fannie Mae.
As a matter of standing policy, both companies told me they would not comment on their holdings nor anything else connected with these stocks.
The government may not even know if there is a threat looming within Fannie or Freddie's portfolios because the entities are not subject to the same degree of disclosure and examination that public companies must provide their investors.
``They (the enterprises) haven't been regulated in the last 10 years,'' says Sean Egan, managing director of Egan Jones Ratings, Inc., of Haverford, Pennsylvania, an independent ratings service. ``Investors don't know the quality of their assets and their hedging. Their huge growth in assets and low growth in capital can't continue.''
Reform Needed
Egan's company rates Fannie Mae ``A'' (``AAA'' is the highest), because Fannie has only a 2 percent capital-to-assets ratio, a financial cushion measure, versus the 8 percent required for a regulated bank. ``That doesn't give us much comfort.''
Although they have resisted and lobbied against reform in the past, chief executives of Fannie and Freddie said they are willing to accept stronger regulation.
``We support legislation that would provide our regulator with full flexibility over our risk-adjusted capital requirement, since it is the regulator's premier tool to ensure we are well capitalized,'' said Franklin Raines, chairman of Fannie Mae before the Senate Banking Committee on Feb. 25.
Critics of the GSEs, though, caution that the debt levels of the enterprises are growing alarmingly fast under the perceived shield of government protection, which draws a painful comparison to the savings and loan crisis of the 1980s.
``It's a precedent,'' says Thomas Stanton, a Washington, D.C.-based lawyer who has called for more stringent GSE policing. ``They (the GSEs) haven't reduced their risk. It could've cost Congress $10 billion to clean up the S&Ls in 1981 if they had acted then. Instead it cost $150 billion when they finally acted in 1989.''
