Rein In Fannie Mae -- Before It's Too Late
The Wall Street Journal recently reported that Fannie Mae has threatened several large financial services firms that had opposed Fannie's interests in Congress. According to statements by the CEOs of AIG, Wells Fargo and GE Capital Services, they, or their firms, were told that Fannie would withdraw its business from them if they remained active in FM Watch, an organization that seeks to limit Fannie's expansion beyond its traditional role in the secondary mortgage markets. Fannie's chairman Franklin Raines, as well as a Fannie spokeswoman, have both denied that such threats were made, but when CEOs of major companies go public with statements of this gravity they must be taken seriously.</br></br>This is not an ordinary commercial dispute, since Fannie Mae is not an ordinary company. Along with its smaller cousin, Freddie Mac, Fannie enjoys a government charter authorizing it to help create liquidity in the residential mortgage markets by purchasing mortgages from banks and others and guaranteeing mortgage-backed securities. Although both Fannie and Freddie are now listed on the New York Stock Exchange, they have so many links to government -- including a special line of credit at the Treasury -- that they are called government-sponsored enterprises, or GSEs.</br></br>As a result, the capital markets do not believe they will be allowed to fail, and provide them with financing at a rate only slightly higher than the Treasury's own borrowing costs. With this government backing and financial advantage, Fannie and Freddie have grown to enormous size and profitability. Today, they carry on their books the credit risk of over 40% of all residential mortgages in the U.S. and are by far the most dominant players in the residential mortgage markets. It is fair to say that if a company is denied the opportunity to sell its mortgages to Fannie or Freddie, or the opportunity to underwrite or deal in Fannie or Freddie securities, it will suffer serious financial harm.</br></br>If Mr. Raines or Fannie did threaten these companies, that is the reason why his threat was menacing. Fannie Mae is to the residential mortgage markets what Microsoft is to computers, with one major exception: Fannie enjoys government backing. Fannie's market power derives from its government connection -- from the fact that it holds, in effect, a government monopoly. A threat from Fannie's chairman, then, is roughly equivalent to the chairman of the Federal Reserve Board threatening to ruin a bank that opposes the Fed in Congress. Such a threat would be seen as a serious matter, out of order for a government official and considerably more serious than the threats that Microsoft is alleged to have made against rivals.</br></br>This episode should alert us to dangers inherent in GSEs. They are sometimes praised as providing private-sector efficiency in the pursuit of government policies, without direct government expenditure. Unfortunately, the true costs are hidden or deferred. In the mid-1980s, Congress had to spend billions to bail out the Farm Credit System, another GSE. And the costs are often not simply financial. While we value the aggressiveness and efficiencies of private enterprises in their pursuit of profit, when these characteristics are hitched to the power of the government through a government-granted monopoly, they can dominate and distort otherwise competitive markets.