Federal Reserve Chairman Alan Greenspan Tuesday urged Congress to rein in Fannie Mae and Freddie Mac, warning that unchecked growth of the housing finance giants will likely threaten the U.S. financial system.
“Most of the concerns associated with systemic risks flow from the size of the balance sheets that these GSEs (government-sponsored enterprises) maintain,” Greenspan told the Senate Banking Committee.
“GSEs need to be limited in the issuance of GSE debt and in the purchase of assets, both mortgages and non-mortgages, that they hold,” he added, implying the size of their holdings and the need to keep growing made them vulnerable.
Greenspan’s testimony comes as Congress works to create a new, tougher regulator for the two mortgage finance giants and 12 Federal Home Loan Banks, after an accounting scandal at Freddie Mac and a Fannie Mae earnings report error last year rattled markets and policy-makers.
Shares in the companies’ stock fell on the Fed chairman’s stark assessment.
Greenspan called for clarity in the government’s backing for the companies -- which are shareholder-owned but congressionally chartered -- saying the current ambiguity had the potential to cause a “very serious” financial problem.
Fannie Mae’s and Freddie Mac’s debt is not backed by the government. But advantages through their charters, including multibillion-dollar emergency credit lines, foster a perception the government would rescue them if necessary.
Greenspan said he believes the companies -- which he said stand behind more than $4 trillion of mortgages -- have grown so big now that if either one got into trouble, the government would have no choice but to bail it out.
‘Elbowing out’ competitors
Fannie Mae said in a statement Greenspan was ignoring the role the enterprise plays in ensuring a steady flow of funds to mortgage markets in all economic weather.
“In times of economic turmoil, our mortgage portfolio purchases provide critical liquidity and stability to the market,” said Fannie Mae Vice President Jayne Shontell.
Greenspan said the package of benefits Congress grants them is tantamount to a subsidy that helps them expand their businesses.
“The problem that exists is because they have a subsidy, granted not by the Congress but by the expectation that government will bail them out in the event of a crisis, they have been able to take a highly competitive position and indeed essentially elbowing out a number of competitors who did not have such a subsidy,” Greenspan said.
Greenspan said he would prefer the mortgage companies operate without any government backing. He said he personally felt privatizing the GSEs should be a goal but said “eliminating the subsidy” was the most important objective.
“There are many ways to enhance the attractiveness of homeownership at significantly less potential cost to taxpayers than through the opaque and circuitous GSE paradigm currently in place,” he said.
White House anxiety
A senior White House official echoed Greenspan’s concerns. The chairman of the White House Council of Economic Advisers, Gregory Mankiw, wrote in the Financial Times Tuesday the congressionally derived privileges Fannie Mae and Freddie Mac enjoy should be reviewed soon and oversight strengthened because even a small problem “could have ripple effects throughout the economy.”
Charter-derived benefits include the ability to draw $2.25 billion each from the Treasury in an emergency, and tax and disclosure exemptions. Because the benefits contribute to investor perception of government backing, they help lower the companies’ borrowing costs.
Greenspan repeated his call for any GSE regulator to be able to adjust minimum capital levels to ensure safety and soundness and wind down the affairs of any failed enterprise.
The Fed chief said Fannie Mae and Freddie Mac do a good job managing interest rate risks associated with fixed-rate mortgages.
“We see nothing on the immediate horizon that is likely to create a systemic problem,” he said.
But, he added, “to fend off possible future systemic difficulties, which we assess as likely if GSEs’ expansion continues unabated, preventive actions are required sooner rather than later,” he added.
