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Observing my upside down America

Mortgage Institutions Pose Systemic Risks: Greenspan


Washington, Feb 26, 2004

Alan Greenspan, the chairman of the US Federal Reserve, warned on Tuesday that the nation’s two big government-sponsored mortgage institutions pose a “systemic risk” that could cost taxpayers dearly in the future.

Mr Greenspan said that Fannie Mae and Freddie Mac, which buy up and repackage billions of dollars’ worth of mortgages every year, have grown so rapidly and accumulated so much debt that they cannot adequately hedge against the risks of financial crises in the future.

The Fed chairman said both companies, which hold about $2 trillion worth of obligations tied to home mortgages, have grown much faster than their competitors because investors thinkbelieve the fFederal government will bail them out in a crisis.

Mr Greenspan said this “implied subsidy” has been a boon to the two companies’ shareholders but provided only modest benefits to home -buyers in the form of lower mortgage rates.

The danger, he said, is that that the companies are using the this implicit Ffeederal backstop to assume more risk and finance their expansion through increased volumes of debt.

“There is a general belief in the marketplace that these securities are backed by the full faith and credit of the United States government,” Mr Greenspan testified at a hearing of the Senate Banking Committee.

Even though the fFederal government does not guarantee the securities of Fannie Mae or Freddie Mac, Mr Greenspan suggested that their special status as “government-sponsored enterprises” and their huge size would make it difficult for Congress to avoid a bailout in the event of a financial calamity. “It’s basically creating an abnormality, which the system cannot close around, and the potential of that is a systemic risk in – — sometime in the future, if they continue to increase at the rate at which they are.”

Shares of both companies dropped in reaction to Mr Greenspan’s testimony. Fannie Mae shares declined $2.65, 3.4 percent, to $76.25, while Freddie Mac slid $1.81 2.8 percent, to $62.12.

Fannie Mae officials quickly lashed back at Mr Greenspan, complaining that many of Mr Greenspan’s his criticisms were based on a Federal Reserve study that it called “seriously flawed.”

“We, of course, disagree with most of his conclusions,” said Jayne Shontell, Fannie Mae’s senior vice president for investor relations. “We believe that the testimony does not appreciate the role offo our mortgage portfolio and the impact of his proposal.”

Mr Greenspan’s lengthy and blunt criticisms are likely to provide new impetus for legislative proposals aimed at tightening the regulatory control over both companies.

Though Mr Greenspan has criticized Fannie Mae and Freddie Mac in the past, he expressed a greater degree of alarm about the potential risks posed by the companies, and he was insistent that Congress act “sooner rather than later.”

Both companies have been under fire for more than a year now, in part because both have admitted acknowledged to a wide variety of questionable accounting practices.

Freddie Mac executives acknowledged admitted last in November that it the company had understated earnings by $5 billion, a move they had hoped would smoothe out the company’s long-term earnings trend and thus assuageassuage investors. In October, Fannie Mae was forced to correct what it said were $1 billion in errors in its recent financial results.

Critics have complained for years that the two companies have been far less transparent in their financial reporting than ordinary financial institutions. But the larger concern voiced by Mr Greenspan is was that the companies may represent a huge and hidden financial liability tha could at some point in the future lead to a heavy costs for taxpayers.

The Bush administration has proposed transferring regulatory responsibility for the companies to the Treasury Department, which might then set new restrictions on their ability to issue debt or their requirements to keep larger amounts of capital in reserve.

Republicans and Democrats on the Senate Banking Committee are trying to craft draw up a bipartisan plan that would create an independent regulatory group, overseen by top officials at the Treasury, the Federal Reserve and the Department of Housing and Urban Development.

Fannie Mae officials quickly lashed back at Mr Greenspan, complaining that many of Mr Greenspan’s criticisms were based on a Federal Reserve study that it called “seriously flawed.”

“We, of course, disagree with most of his conclusions,” said Jayne Shontell, Fannie Mae’s senior vice president for investor relations. “We believe that the testimony does not appreciate the role fo our mortgage portfolio and the impact of his proposal.”

Originally chartered by Congress, Fannie Mae and Freddie Mac were initially created to expand the pool of money for home mortgages at a time when few banks or savings institutions operated on a nationwide basis.

The two companies essentially buy up mortgages from local lenders and bundle the loans into large securities, which they then resell on to financial markets. Today, Mr Greenspan said, the companies stand behind about $4 trillion worth of mortgages – — about three-quarters of all single-family mortgages in the United States.

Mr Greenspan emphasized that Fannie Mae and Freddie Mac had done a good job of managing their risk thus far. But he said their total volume of outstanding debt could soon exceed the debt of the Federal government itself.

— NY Times

Written by Ben

November 5, 2009 at 12:42 pm

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