Prescriptions for Fannie and Freddie

As policy makers work to ease the strain on the mortgage giants Fannie Mae and Freddie Mac, a consensus is emerging that the two companies will have to look substantially different in the long term.

Leading figures from across the ideological spectrum say that the companies, which were created by Congress to support the housing market, must be restructured so that they do not threaten the financial system. These voices include Republicans, many of whom have long been critical of the outsize roles of Fannie Mae and Freddie Mac in the mortgage market, and some Democrats, who have generally been more supportive of the companies.

Proposals for the companies include making them government-owned and breaking them up into smaller firms, phasing them out of existence entirely, or simply limiting their operations to certain core areas like affordable housing as well as limiting their ability to borrow money.

On Wednesday, speculation about a government intervention sent shares of the companies tumbling by more than 20 percent. The stocks have plunged more than 60 percent this month, with Fannie Mae ending the day at $4.40 and Freddie Mac at $3.25. The price of bonds issued by the companies surged, meanwhile, as some investors indicated that any effort by the Treasury Department to help the companies would benefit bondholders. (See a discussion of potential bailout options below.)

The moves in the stocks and bonds reflect investors’ growing belief that the government will have to come to the aid of the companies under the authority Congress gave to the Treasury in July. It remains unclear, however, exactly what form a rescue package would take.

The government created Fannie Mae during the 1930s to help bolster an ailing housing market, and Freddie Mac was chartered in 1970 to serve a similar function. The companies were privatized over the years but they remained quasi-governmental entities both in appearance and reality. Congress pressured them to make housing more affordable through explicitly stated goals, and they were able to borrow cheaply because investors believed the government would back the companies if they faltered.

The companies support the housing market by buying loans from banks and other lenders, allowing those firms to make more loans. Today, Fannie Mae and Freddie Mac own or guarantee nearly half of all loans outstanding, and the market has become increasingly dependent on them as the private mortgage market has come to a virtual standstill.

With the companies’ stock falling and their ability to raise capital dwindling, government officials met with executives of Freddie Mac on Wednesday. The Treasury Department has said only that it is monitoring the situation closely.

Arthur Levitt Jr., chairman of the Securities and Exchange Commission in the Clinton administration, described the companies as “neither fish nor fowl.” He said the country had long put off discussions about the implicit government backing of the companies, which Congress made explicit last month by empowering the Treasury to infuse billions of dollars into them.

“The fabric of those companies was so intertwined with its political patrimony that ordinary considerations were put aside for what was or wasn’t politically acceptable,” Mr. Levitt said in a telephone interview. “As a result of that, the way one would operate a business according to business standards gave way to operating a business in a way that was palatable to a political system.”

Mr. Levitt and several other public figures say the immediate course of action for the government should be to stabilize the companies, given the vital role that they play in the financial and housing markets. Over the longer term, these people say, the companies’ dual public-private role should be reconsidered. (Should they be allowed to fail? See the video to the left for a discussion.)

Alan Greenspan, the former Federal Reserve chairman, has said that the companies should be acquired by the government and then broken up into smaller firms and sold to investors. That would remove the federal backing from the firms and reduce the risk posed by the failure of any individual firm.

On Tuesday, Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, echoed that prescription on Bloomberg Television. And in a newspaper column a few weeks ago, Lawrence H. Summers, a Treasury secretary in the Clinton administration, wrote that the companies should be broken up, with some functions remaining public and others being privatized.

CONTINUED : Mortgage giants holding up well, comparatively

---

1 | 2 | Next >