It never Raines

FINANCE & ECONOMICS
Fannie Mae

Jan 6th 2005 WASHINGTON, DC
From The Economist print edition

The mortgage giant loses its boss and looks for capital

JUST three months ago the Office of Federal Housing Enterprise Oversight (OFHEO), an obscure body that regulates Fannie Mae, said that it had sniffed out some fishy accounting at America's giant mortgage company. Used to brushing off pesky critics, Franklin Raines, Fannie Mae's chairman and chief executive, scoffed at the allegation before Congress and turned to the Securities and Exchange Commission (SEC) to overrule the meddling regulator. But the SEC backed OFHEO, and shortly before Christmas Mr Raines and Tim Howard, Fannie Mae's chief financial officer, lost their jobs.

Yes, said the SEC, Fannie Mae had been improperly smoothing losses on derivatives contracts used to hedge its $900 billion mortgage portfolio. That made the accounts look better—good enough, indeed, to trigger fat bonuses for top executives. The company will have to restate its earnings for the past four years to record a $9 billion hit: this week it appointed a new auditor, Deloitte & Touche. Its capital will be dragged below regulatory requirements, especially since OFHEO, dizzy with its new-found clout, recently lifted the bar by 30%. To shore up its balance sheet, Fannie Mae said on December 29th that it would sell $5 billion in preferred stock.

However, it will either have to raise a lot more or slow its growth to a standstill to reach the new levels. And asset sales are unlikely, because they would upset the politically sensitive mortgage market.

To many, this is an overdue come-uppance for a company that has been known to call its detractors “anti-housing” and “pencil-brains”. Fannie Mae and its smaller sibling Freddie Mac, which also stumbled over accounting rules in 2003, enjoy special privileges because they buy up home loans, providing liquidity to the housing market. A $2.25-billion line of credit to the Treasury, tax advantages and low capital requirements together imply a government guarantee that translates into lower borrowing costs. The Congressional Budget Office puts the value of this implicit subsidy to the two mortgage giants at $19.6 billion a year.

Does Fannie Mae really deserve to be fed by taxpayers? When it was formed in the wake of the Depression, the company did much to revive America's collapsed housing market. But now there is a vigorous secondary market for jumbo mortgages that could easily soak up the smaller loans dominated by Fannie Mae and Freddie Mac. The companies have also strayed from their mission of helping people afford their own home: they lag behind regular mortgage banks in funding first-time home-buyers, especially those from ethnic minorities. The subsidy is all the more objectionable when so much of it seems to go into shareholders' and executives' pockets and on a huge, and so far effective, lobbying effort aimed at preserving its status. And the subsidy has fuelled such fast growth and high leverage (Freddie and Fannie have $1.7 trillion in debt outstanding) that Alan Greenspan, chairman of the Federal Reserve, has mused that a blow-up could do great damage to the American economy.

Recent events have given Fannie Mae's critics stronger arguments than ever for reform. The Bush administration is no fan; and Richard Baker, who chairs the House of Representatives committee overseeing Fannie Mae, says, “Nothing is off the table including the line of credit.” In practice, change is likely to be mild, focusing on strengthening regulation. Lawmakers will tussle over whether the Treasury should take over, or whether OFHEO should have the authority to approve new products. Reformers hope to win receivership powers for OFHEO so that it can wind down Fannie Mae should it run into trouble; appointing a potential receiver might persuade investors that Congress would not bail the company out.

If history is a guide, any change will be hard won. Fannie Mae has many friends in Congress. But even its keenest supporters are scandalised by Mr Raines's retirement package: $19m in severance pay and a pension of $1m a year. “The usual defenders have remained quiet,” notes Mr Baker.

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