Testifying before the House Banking Committee last week, U.S. Rep. Richard Baker (R., La.) said he wants the President's Working Group on Financial Markets to take a look at pending legislation to reduce risks posed to the financial markets.

While Baker suggested that OTC derivatives and hedge funds deserve further exploration, he spoke at length on the risks of agency securities - those of Fannie Mae, Freddie Mac and the Federal Home Loan Banks System. He has sponsored a bill - HR 3703 - to strengthen the regulation of the agencies.

"I have come to the realization that the growth in the size of the housing government-sponsored enterprises has been significant," Baker said in his testimony. "Allow me to put this in perspective and discuss my findings that, when examined in light of the Working Groups' findings and recommendations, demonstrate that the variables identified by the Working Group - high leverage, wide scope, and adequate risk management - may be present in the GSEs."

He stated that the $1.4 trillion of GSE debt combined with the $1.2 trillion of mortgage-backed securities held by the GSEs, means that they hold almost the same amount as that of the $2.7 trillion Treasury debt market. In fact, within the next three years, Baker sees GSE debt doubling that of the Treasury.

With banks holding over $210 billion of that debt in mid year 1999 - one-third of total bank capital - Baker said a review of their implications is warranted. "Should the housing market encounter problems, investors may turn elsewhere than GSE debt as a safe haven, raising questions about the ability of the GSEs to raise capital to defend their positions should dramatic losses ever be incurred," Baker said.

Regarding the implicit-guarantee the GSE securities hold, Baker reiterated statements made be Treasury Undersecretary Gary Gensler a few weeks ago. "Undersecretary Gensler responded, I think that Congress has actually stated that GSE debt is not guaranteed by the U. S. government and such statement is actually contained in the prospectus and on the face of the debentures of all GSE debt.'"

He then noted the market's reaction to Gensler's comments, saying, "Only when assured that Treasury's position on the treatment of agency debt had not changed, did the markets resume historical practices." He said that the market misinterpreted this, as the GSE securities really were backed by the full-faith and credit of the U.S. government, when there really is no such guarantee.

David Jeffers, vice president of corporate relations at Fannie Mae, reacted harshly to Bakers comments in a prepared statement. "Every reputable observer agrees that Representative Baker's bill is going nowhere because it's anti-housing," he said. "Even Baker as recently as yesterday said it's going nowhere."

Jeffers added that Fannie Mae is not going to comment every time unwarranted comments of the company's safety and soundness are made. "Our regulator - the Office of Federal Housing Enterprise Oversight - has found that Fannie Mae exceeds safety and soundness standards in all areas," he said.

Baker, in his testimony, stated that the growth of GSEs is not necessarily wrong, as long as they stay within their congressionally chartered missions. "However, to maintain their level of profitability, the GSEs will have to grow even larger and take on considerably more risk," he said. "This is why we must begin to mitigate systemic risk by promoting market discipline, transparency, and improved supervision and regulation on all three of our housing GSEs."

He said that while times are good, it is best to start preparing for times "when the only thing standing between losses of a GSE and your constituent's wallet is ... good judgment."

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