use of complex derivative transactions and its ultimate collapse have provided
Chairman Alan Greenspan another angle from which to attack government-sponsored mortgage firms like
"I see this as part of a series of warnings that Alan Greenspan has tried to deliver to Congress for several years now," said Peter Wallison, a resident fellow at the American Enterprise Institute for Public Policy Research.
"He's saying, if you're as interested as you seem to be in the risks that Enron created, then you should be equally interested in the risks that these GSEs
government-sponsored enterprises are creating. You should not be complacent about what is occurring here."
Greenspan took aim at mortgage agencies Monday night, complaining about the risks associated with the quasi-government agency's derivatives deals.
In remarks delivered via satellite to the Institute of International Finance, Greenspan said deregulation in the financial markets has helped reduce economic volatility and has created a much more flexible secondary mortgage market, which in turn has helped build home ownership.
But he also expressed concern about the large interest-rate hedging efforts made by mortgage agencies such as Fannie Mae and Freddie Mac. The support being extended by the U.S. government to these companies could lead counterparties, or firms that the GSEs do business with, "to apply less vigorously risk controls that they apply to manage their over-the-counter derivative exposures," he said.
While counterparties should be able to manage this risk effectively, the perception of government support for these companies poses risks to the financial markets, he said.
The exact level of government involvement in GSEs is a matter of some debate. While set up by the government, they are shareholder owned and no guarantee of their credit is explicit. But it's customarily assumed by the market that the government wouldn't allow GSEs to fail, which lowers their cost of borrowing.
In a written response, Fannie Mae said that it is a "very small" user of derivatives, that the firm's credit rating is very high and that it sees no evidence that counterparties are applying "anything less than careful judgment."
A spokesman at Freddie Mac said the firm uses derivatives as "an end-user rather than as a speculator" and that the counterparties understand that.
Still, complaints about government-sponsored enterprises extend beyond their use of derivatives. GSEs buy mortgages from lenders and convert them into securities that they then sell to investors like pension funds. By expanding mortgage availability, lenders are able to offer more loans.
But Fannie Mae and Freddie Mac enjoy unique benefits under federal law, and as a duopoly, they dominate the industry. Both firms are exempt from some
Securities and Exchange Commission
requirements, as well as state and local taxes. In addition, both firms enjoy a $2.25 billion line of credit from the Treasury Department, though it has never been used.
In June 2000, Greenspan warned taxpayers about the large, hidden costs GSEs impose because taxes ultimately finance the billions of annual subsidies at the expense of other initiatives.
While supporters say the agencies keep mortgage costs low, critics say the removal of government backing would subject these companies to more stringent market regulation, create competition, heighten consumer choice and protect taxpayers.
Still, all efforts to rein in GSEs have so far met with fierce opposition.
"The GSEs are tremendously powerful, and every effort to reform them is an uphill battle," said Wallison of the American Enterprise Institute. "What Greenspan's comments do is slightly increase the chances of some kind of legislation, but I don't think anyone would be in a position to say it changes the calculus."
"The calculus always has to be, at this stage at least, that they have such political power that it would be foolish to bet against them."
Investors were taking that advice to heart Tuesday. Despite an initial slide in the share prices of Freddie Mac and Fannie Mae, both stocks came back by midday. Freddie Mac was down just 0.14% to $65.76 while Fannie Mae was up 0.16% at $80.43 in recent trading.
Freddie Mac also was helped by a sharp rise in first-quarter profits Tuesday as low mortgage rates fueled lending. The company said net income grew to $893 million, or $1.19 a share, compared with $719 million, or 96 cents a share, a year ago.
Operating earnings and diluted operating earnings per share, excluding an accounting charge for derivatives, were $1.413 billion and $1.94, respectively. The company also raised its guidance, saying it expects earnings growth of about 16% to 18% in 2002.