Time to Bust Up Fannie and Freddie (Greg Hartz and Mark Millsap Commentary)

by Greg Hartz and Mark Millsap  on Monday, Jul. 5, 2004 12:00 am  

Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac) were started with government capital and later privatized and traded on the New York Stock Exchange.

We believe the time has come to bust up Fannie Mae and Freddie Mac, which have become the final guarantors of the bulk of the residential mortgage debt in this country.

These huge entities perhaps have the strongest lobbying groups in Washington, so the job will require much fortitude and tenacity.

Not long ago, our country went through a financial crisis in home mortgage finance with the savings and loan business.

The federal government was called in to pay off the guaranteed liabilities (the insured deposits) and to make an orderly liquidation of the assets.

Fast forward to today. We have Fannie Mae and Freddie Mac, which have taken the place of the savings and loan industry from a financing perspective.

A multitude of mortgage originators has taken the place of S&Ls on the asset side. Many are barely capitalized operations that simply collect an origination fee and transfer the risk to Fannie and Freddie.

Thus, the potential hazard of guaranteed deposits that existed in the S&L business has been transferred to these two behemoths. Fannie and Freddie have taken the risk and run with it, leveraging their balance sheets to a point where any sober observer would consider both undercapitalized.

Fannie is leveraged (total debt to total capital) at more than 45 times, and Freddie at more than 26 times. These ratios imply less than a 4 percent margin for error in the asset portfolio for Freddie and less than a 2.5 percent margin of error for Fannie.

Fannie and Freddie have obtained this leverage on the cheap, as the debt market has taken the "too big to fail" lessons of the past 20 years and assumed that this doctrine applied to Fannie and Freddie.

Wall Street has been only too happy to assist. The market for these securities has mushroomed to the point that there are daily offerings marketed with a wink and a nod that these credits are unquestionably "too big to fail."

There is no doubt that Fannie and Freddie have been extremely effective in spreading home mortgage finance far and wide in this country.



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