A New Job for the Fed

Reining in two outsized giants of the home-loan trade

When any financial institution gets so big that its collapse could rattle the markets and shake up the economy, it's time for the Federal Reserve to regulate it.

That's the reasoning behind a bill in Congress that would put the two giants of the home-loan industry under the eye of a better government regulator.

Right now, the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Mortgage Corporation ("Freddie Mac") are regulated by an office within the Department of Housing and Urban Development.

That set-up was fine a decade ago when these two government-sponsored enterprises were much smaller. But since they have become the largest financing source for home mortgages - lending some $2.1 trillion in their worthwhile mission to help low and middle-income Americans, a traditionally underserved market, buy residences. They've done their job well, perhaps too well, say some opponents, now that middle-income Americans are arguably no longer "underserved."

A small passage in President Bush's proposed federal budget reveals that over the last 3 to 4 years, debt levels for Fannie Mae and Freddie Mac have grown by 24 percent a year. At that pace, their debt will overtake the federal debt in 2005, and reach a whopping $2.7 trillion.

While these two companies are not fully backed by the US Treasury, the financial markets apparently perceive that they are. This "implied" guarantee is what's understood to be a mostly symbolic line of credit.

Fannie and Freddie also enjoy perks that have helped them grow. They don't have to pay certain taxes, or register their securities, for example. They have a $2.25 billion line of credit from the Treasury, but could actually borrow up to $4 billion.

It's clear Americans will be better off when:

* Congress and the Treasury make it clear that they will never bail out Fannie Mae and Freddie Mac.

* The two are regulated by an agency with the money, muscle, and expertise to do the job.

The bill that would do the latter has been introduced by Rep. Richard Baker (R) of Louisiana, who chairs the relevant House subcommittee. It does not call for an outright repeal of Fannie and Freddie's line of Treasury credit, but does require a study of that controversy.

When the Clinton Treasury folks endorsed the idea of getting rid of the credit line, the bond markets were shaken - perhaps a sign that investors might be nervous about the government-backed safety of Fannie and Freddie.

Indeed, the two giants have been criticized for using the suggestion of possible market instability as a convenient tool to keep more-powerful regulatory fingers off them.

The Fed is the ultimate regulator of complex financial systems, with a strong and reputable eye toward financial risk. It's well positioned to help put some brakes on these overgrown entities.

(c) Copyright 2001. The Christian Science Monitor

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