Fannie Mae & Freddie Mac: When Will the Government Learn?

The subprime crisis in the U.S. has resulted in the decline of many companies. Many banks including large ones had to write off millions. The decline is not limited to banks and home loan companies alone.

Out of the total $12 trillion in mortgage debt today, two companies – Fannie Mae and Freddie Mac – own or guarantee half of the debt. Both were established by Congress to make homes affordable for lower and middle income families. They do not provide home loans. Both buy mortgages from banks and home loan companies allowing them to make even more mortgages. They take on the risk of possible default.

The decline of Fannie Mae and Freddie Mac is not an overnight event. It has been building up over the years. Some experts feel the main reason for the decline is their unfair insulation from the real world – they are not subject to the same financial standards and taxes as their competitors. They are also exempt from state and federal taxes.

To be fair, the government did try to regulate them by setting up the Office of Federal Housing Enterprise Oversight in the early 1990s.

They were required to meet certain capital reserve requirements but still much less than their competitors. When the accounting scandals broke out at both companies a few years ago, the government had the perfect chance to set up a powerful regulator and rein them in, but the fear of stemming the housing boom probably held the government back.

It would be wrong to blame the lack of regulation alone for the decline of these two companies. The Securities and Exchange Commission tried to get more actively involved in regulating them, but both companies stymied their efforts.

Instead of addressing their critics, these companies forged alliances with them and other activist groups and made huge contributions to non-profit groups. These alliances and contributions were made to buy off the activists and groups and to make it more difficult for them to criticize the companies.

Congress is now debating on a legislation which if passed could give these companies even more power and allow them to venture into new mortgage-related businesses. Instead of making these companies more powerful, what Congress needs to do is to set up a regulator who can effectively regulate these companies and, at the same time, decide on some sort of a capital cushion for them.

The value of Fannie Mae and Freddie Mac’s mortgage assets are declining along with home prices everywhere. If these companies fail, the taxpayers could be left with the losses.