Editorials

A plan announced by the Bush administration and Federal Reserve has deflated a building crisis concerning Fannie Mae and Freddie Mac, key agencies in the housing financial market.

Under the plan the government will lend Fannie Mae and Freddie Mac money through the Federal Reserve and the Treasury — and, if necessary, buy stock in both. Lenders responded favorably, promptly buying bonds from the troubled agencies.

The action was important to the housing industry and homebuyers, since Fannie Mae and Freddie Mac provide most of the mortgage funds in today’s housing market, said David C. John, an economic policies expert at The Heritage Foundation.

If the crisis had continued to grow, lack of cash could have dried up lending, sinking the already depressed housing sector even lower by halting home sales, analysts say.

While the plan is good news in helping the current situation, it does nothing to resolve the fundamental cause of the problem, John pointed out. Without major structural reform in the housing finance industry, he predicted, it is probable the whole situation will recur in a few years.

Fannie Mae and Freddie Mac are owned by private stockholders, but both really are artificial government creations very different from real private sector companies, John pointed out.

“Both companies are remnants of the Great Society, when big government entities were thought to be the only way to achieve social goals,” he explained. “The fact both were later privatized does not change their essential nature as government-sponsored dominators of a market rather than as participants in it.”

Unfortunately, he added, these problems have not resulted in any significant reforms to the overall structure of either entity.

Financial experts have warned “for decades” that both entities lack sufficient capital, made up of both investors’ money and retained earnings, to protect against losses, John said. Congress considered higher standards in the 1990s, “but many of the same congressional leaders who head their oversight committees today bowed to a sustained and high-powered lobbying campaign that took all the teeth out of the reform.”

Congress should take action to bolster this temporary fix by rapidly enacting proposed short-term reforms, he suggests. This includes legislation to increase both agencies’ credit line with the U.S. Treasury and enable Treasury to buy stock in both. This temporary measure should be exempt from the debt limit because otherwise, when the support of Fannie Mae and Freddie Mac ends, the debt limit would remain artificially high. These would be strictly one-time moves.

Legislation strengthening the Office of Federal Housing Oversight is needed to provide the agency power to enforce decisions has passed both the House and Senate and needs to be enacted into law, John said. It is important to keep the Federal Reserve role not be enhanced, he added.

A longer run plan should be for Congress to break up the existing system of massive government- sponsored entities that dominate housing finance and replace it with a much larger number of genuine private sector companies, John said.

Strict steps are needed by both regulators and industry to ensure quality controls can weed out low- quality mortgages and properly grade these securities to build confidence of future investors in what they are buying.

Boiling it down, Fannie Mae and Freddie Mac have caused turmoil due to poor management and inadequate capital.

An immediate crisis has been cooled by the administration and Federal Reserve plan, but Congress needs to act on reforms now to make sure it doesn’t happen again.

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