Mortgage debt cap urged
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WASHINGTON Federal Reserve Chairman Alan Greenspan warned yesterday that the rapid growth of mortgage giants Fannie Mae and Freddie Mac needs to be curbed to head off a major risk to U.S. financial markets and taxpayers.
Federal Reserve Chairman Alan Greenspan testified yesterday that mortgage giants Fannie Mae and Freddie Mac's debt could pose a threat to the U.S. financial system.
Fannie Mae and Freddie Mac are private institutions created by the federal government to make mortgage markets run smoothly. They borrow money by issuing bonds, then use those funds to buy mortgages from banks and resell them to investors, ensuring a steady flow of money for mortgages everywhere in the nation and increasing home ownership.
Fannie and Freddie, both Fortune 500 companies, have grown into two of the biggest financial companies in the world. They stand behind $4 trillion in home mortgages, or more than three-fourths of the single-family mortgages in the United States.
Greenspan's worry, shared by chief White House economist Gregory Mankiw, is that too much of the mortgage market is concentrated in Fannie Mae and Freddie Mac, which could trigger a crisis if interest rates rise suddenly and unexpectedly, causing the mortgage giants to have trouble making payments on their debt.
Greenspan called for limits on how much debt the two institutions can issue and how many mortgages they can hold.
Mankiw, in a column yesterday in the British newspaper the Financial Times, warned that Fannie Mae and Freddie Mac are "a source of systemic risk for the U.S. financial system."
The sheer size of their debt about $2.4 trillion combined and their dominant role in the housing market is raising concern that a crisis at either institution could undermine U.S. financial markets and trigger at least a temporary freeze of the mortgage market.
To avert such a collapse, Congress might have to authorize a bailout and taxpayers would have to foot the bill.
"The Federal Reserve is concerned about the growth and the scale of the (two institutions') mortgage portfolios, which concentrate risk at these two institutions," Greenspan said.
Fannie Mae and Freddie Mac both issued statements taking issue with Greenspan's comments. The heads of both institutions are due to testify to the Senate Banking Committee in a second-day of hearings on the issue today.
"We, of course, disagree with most of his conclusions, but appreciate that he has now made his strongly held views public," Jayne Shontell, senior vice president for investor relations at Fannie Mae, said in a lengthy written statement.
Greenspan acknowledged that Fannie Mae and Freddie Mac have managed their risk well in the past, and he emphasized that there doesn't appear to be an imminent problem.
The institutions engage in complex financial transactions known as hedges to reduce the risk posed by sudden changes in interest rates. But financial market history has shown that even the best minds in finance can be brought down by unforeseen developments.
"Nobody's entirely sure if the hedging formula comes under a severe enough test, if it will hold," said David Wyss, the chief economist at the Standard & Poor's rating agency in New York.
Greenspan argued that the risks were excessively concentrated in large institutions that were potentially subject to human error. Most risks in the U.S. financial system are spread across many smaller players subject to market forces.
Greenspan also cited a Federal Reserve study that concluded Fannie Mae and Freddie Mac benefit from an implied subsidy from the government, because most investors assume they would be rescued in a crisis. That perception allows the institutions to borrow money more cheaply and pay higher prices in the market for mortgages, squeezing out potential competitors.
The profits earned by this implied subsidy, Greenspan said, accrue mainly to shareholders and managers of the two companies, a finding the companies dispute.