The economic consequences of the failure of any one of the government sponsored enterprises - Fannie Mae, Freddie Mac and the Federal Housing Finance Board - could be great, according to witnesses at a House Budget Committee hearing on the housing GSEs last week.

Headed by Rep. John Sununu (R., NH), the committee heard testimony on how the rapid growth of the GSEs and the GSE-issued debt accumulated by financial institutions could impact the economy should any of the enterprises fail, or the economy takes a turn for the worse.

"We intend to shed light on the GSEs, rather than engage in any debate over policy prescriptions," Sununu said in his opening remarks. "The GSEs are enormous and complex entities and we should understand the impact an economic downturn might have on the GSEs themselves and on the holders of their securities."

Bert Ely of Ely & Co. spoke as an independent consultant and offered some surprising remarks. Despite repeated statements made by Congress and the GSEs, Ely said that just by the nature of the agencies' status as GSEs, the likelihood that the federal government would bail them out of serious financial problems was "nearly certain."

"Until such time as Fannie and Freddie can be transformed into genuinely private-sector firms by eliminating their special privileges, Congress must ensure that a reliable mechanism is in place to rescue Fannie and Freddie should one of them stumble financially," he said, noting that any rescue mission should be "executed as quickly and smoothly as possible."

Thomas McCool, director of financial institutions and marketing issues at the General Accounting Office, provided examples of times when the government offered assistance to Fannie Mae when it experienced difficulties in the mid 1980s, leaving the potential for taxpayers to pay for the GSEs' debt and mortgage-backed securities obligations if another crisis is to occur.

Because of the "implicit guarantee" the GSEs' MBS and other debt issuance carry, the GSEs are able to borrow money more cheaply, without practical volume restrictions faced by a private triple-A rated company, said Armando Falcon, director of the Office of Federal Housing Enterprise Oversight - the safety and soundness regulator of Fannie Mae and Freddie Mac.

Additionally, McCool stated that in the 1992 Act that created OFHEO, Congress correctly recognized that the GSEs "face a natural tension between maximizing profitability for their shareholders and fulfilling their housing mission."

In addition to the impact of Fannie Mae and Freddie Mac, William Apgar, commissioner of the Federal Housing Administration and acting chairman of the FHFB, discussed the role the Federal Home Loan Banks have in limiting economic risk.

Apgar pointed to the 1999 Financial Modernization Act, which now allows the FHLBanks to access low-cost funds for community financial institutions to support small businesses, small farms and small agri-businesses, as well as greater access to areas with underserved populations.

The arbitrage issue, which has long plagued the FHLBank System, has been modified, which will ultimately create a totally mission-related balance sheet. Apgar noted that as recently as five years ago, only 40% of FHLBank assets were mission-related assets, which has grown to 75%.

"The development of Acquired Member Asset programs will help the FHLBanks to develop core mission assets to replace arbitrage investments and, at the same time, increase competition in the secondary market," he said.

The participants in this hearing particularly wanted to steer clear of other thorny GSE-related issues being discussed in the Banking Committee's subcommittee on capital markets, where there is currently pending legislation to tighten control over the housing GSEs. - FM

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