GAO Scrutinizes Fannie, Freddie Alternatives
A year after the collapse of securities firm Lehman Brothers, the mortgage industry is taking a close look at mortgage finance and securitization giants Fannie Mae (FNM) and Freddie Mac (FRE). A handful of proposed alternatives to the structure of the companies, now in conservatorship, include a network of smaller securitization entities and a massive switch to utility companies. The proposed revamps of Fannie Mae and Freddie Mac pose inherent benefits and risks to taxpayers, the mortgage finance industry and the government-sponsored enterprises (GSEs) themselves, according to a report by the Government Accountability Office (GAO) last week. The GAO turned a scrutinizing eye on the main alternatives proposed, including a move to reconstitute the GSEs as for-profit corporations with government sponsorship and additional restrictions. This option would effectively add controls to minimize risk in the system, GAO said. It would eliminate or reduce the GSEs' mortgage portfolios, establish executive compensation limits, or completely convert the GSEs from shareholder-owned corporations to lender-owned firms. This model is not entirely without risk, however, as investors might be unwilling to invest capital in reconstituted enterprises unless the Treasury Department assumed responsibility for losses incurred during their conservatorship, GAO said. Any transition to a new structure would need to consider the GSEs' dominant position in housing finance and be implemented carefully -- and perhaps in phases -- to ensure its success. "Continuing the enterprises as GSEs could present significant safety and soundness concerns as well as systemic risks to the financial system," GAO said in the report. "In particular, the potential that the enterprises would enjoy explicit federal guarantees of their financial obligations, rather than the implied guarantees of the past, might serve as incentives for them to engage in risky business practices to meet profitability objectives." The GAO also noted a move to turn Fannie Mae and Freddie Mac into securitization utilities, landing them under federal regulation to control the performance of what is becoming a monopoly of sorts. The structure mimics the utility-type regulation enjoyed by electric companies at a state and local level. It would give regulators greater control over Fannie and Freddie's performance at a time when the share of agency mortgage-backed securities (MBS) issuance -- including the GSEs and Ginnie Mae -- has swelled since 2006, rising to 97% of the market share in 2008 as private-label issuance dried up. GAO said, however, "it is not clear that the public utility model is an appropriate regulatory structure because, unlike natural monopolies such as electric utilities, the enterprises have faced significant competition from other providers of mortgage credit over the years." Having emerged from years of this competition among issuers of MBS, the GSEs may continue to play a prominent role in securitization. Another proposed alternative to their current structure would be to establish the GSEs as government corporations or agencies that focus on purchasing mortgages and issuing MBS. This move would eliminate Fannie and Freddie's held mortgage portfolios, but would not necessarily motivate risky business practices in light of the overarching government role in their business, according to the GAO. This option may present a complex and challenging business model for a government entity, however. It would also present inherent risk to the government through the entities' role in a mortgage market that has seen significant losses in recent years. "This risk may be heightened if a government entity were expected to continue purchasing mortgages and issuing MBS during stressful economic periods when the potential for losses may be greater than would otherwise be the case," GAO said. Another proposed alternative, privatizing or terminating Fannie Mae and Freddie Mac, would disperse the lending and risk management obligations through the private sector. The mortgage banking sector, led by the Mortgage Bankers Association recently called for a new system of MBS issued by securitization entities, which could be made by resolving Fannie and Freddie and re-purposing their infrastructure. Write to Diana Golobay.