Staking out New Boundaries: Last Year Brought Unexpected News from Freddie Mac, Which Sparked Renewed Debate over Regulatory Reform of the Secondary Market Entities. Reform Legislation Stalled as 2003 Drew to a Close. What's the Outlook for Action in 2004?

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THE MORTGAGE FINANCE INDUSTRY and many in the nation's capital markets and economic policy circles held their breath for a moment last summer when news of accounting irregularities by Freddie Mac surfaced. Renewed concern, though less pronounced, returned in the fall when reports surfaced about Fannie Mae having a minor accounting glitch of its own.

Since then, the news has reinforced calls for more oversight of the government-sponsored enterprises (GSEs), but not yet produced action.

It is one thing for a private corporation to have these problems, even if self-inflicted, but when the companies are twin economic engines like Fannie and Freddie--which together carry on their balance sheets $1.6 trillion in assets and have outstanding debt totaling $1.5 trillion--there's a tendency to be more judicious before pulling the trigger on regulatory reform.

That is not to say no one has noticed. There have been numerous suggestions for change, most notably proposals to tighten the regulatory relationship between the two GSEs and the federal government.

These suggestions have largely centered on legislative ideas aimed at establishing a new, independent regulator for Fannie Mae and Freddie Mac that would bulk up, or simply replace, the Office of Federal Housing Enterprise Oversight (OFHEO). OFHEO is currently the regulator of the housing GSEs for safety and soundness. The Department of Housing and Urban Development (HUD) is charged with oversight of the GSEs' efforts to serve their housing mission.

A reform bill, the Secondary Mortgage Market Enterprises Regulatory Improvement Act (H.R. 2575), drafted by Rep. Michael Oxley (R-Ohio), chairman of the House Financial Services Committee, would create a new independent regulator inside the Treasury Department, a move with considerable support--including from the Mortgage Bankers Association (MBA).

In a letter to key House and Senate banking committee members, MBA stated that "Treasury's proven expertise in financial regulation can only serve to strengthen the ... process. The GSEs should not use their special advantages to compete in the primary market or expand into other markets that are already well served by others."

At MBA's Annual Convention & Expo in San Diego in October, Chairman Robert M. Couch, CMB, said the association polled its members "for input" and discovered a "remarkable consensus" favoring the Treasury oversight.

There are two components of the current oversight of the GSEs that cover financial safety and soundness and the housing mission of the two secondary market entities. Moving oversight to Treasury, which already regulates national banks and thrifts, could involve giving the department authority over new activities and products of the GSEs (the housing mission), which is currently regulated by HUD. Combining both elements of oversight under one regulatory body inside Treasury, in effect, could put a more proactive focus on "safety and soundness" for the two secondary market giants.

Proposed changes to the current system of oversight for the GSEs can produce more than the typical political outcry on Capitol Hill, and in some cases in the capital markets. For example, when a Treasury Department official suggested in testimony eliminating a $2.25 billion line of credit with Fannie Mae and Freddie Mac, the outrage was heard near and far. Sen. Jim Bunning (R-Kentucky), who serves on the Committee on Banking, Housing and Urban Affairs and the Subcommittee on Financial Institutions, said the "markets went haywire" at the suggestion.

In the last two years, the topic of suggested changes in GSE oversight have been floated in various congressional hearings, conferences and legislative proposals. Some of these changes have included:

* new oversight of the GSEs' capital requirements and monitoring of their portfolio risks;

* doing away with presidentially appointed directors (to end their political lobbying efforts);

* providing a regulator with the authority to put either GSE into receivership if it becomes severely undercapitalized; and

* weakening or removing the government-sponsored enterprise status for Fannie Mae and Freddie Mac. …