Fannie & Freddie go to Rehab

Rumor has it that last week the Federal Government was considering granting Fannie Mae & Freddie Mac (F&F) ‘explicit guarantees’ of its debt.

Bad idea and the government quickly denied it. But it brings to mind what these groups do and how they affect the markets.

Right now both F&F benefit from an ‘implied guarantee’ meaning that, because the two companies were chartered by the Federal government they’re able to issue debt at a lower rate than comparable corporate debt. Thing is, this ‘implied guarantee’ gives the impression that Congress would bail out F&F in the event of a default, at the taxpayer’s expense. Which is actually not the case.

On the surface the implied guarantee might make sense, given F&F’s contribution to the US housing market and the economy, by enabling wider homeownership and by adding liquidity to the mortgage market through packaging of mortgages into securities. Plus the fact that Fannie was originally chartered as a government agency under FDR in response to the housing issues of that day.

Problem is that today both groups are – surprise! – public listed corporations just like Citi, Merrill and Google, not government agencies like the US Treasury Department or the IRS. This means they should be held accountable to shareholders. And have a board of directors, and all of the other corporate governance-related activities that public companies get to do.

Problem is they hadn’t always been doing this very well. If you’ve been following the business news in recent years, both F&F have been plagued by internal control issues. Fannie’s was so severe that it had to undergo the largest restatement in US history. An investigation revealed accounting fraud initiated by former senior executives and aggressive lobbying on the part of senior executives as to render its regulator, OFEO ineffective, to say the least.

Sure, other companies have done this before but given the impact that FNMA has on the US – no, the world – economy, this is no small lobbying effort. The problem was so severe that the Wall St. Journal called FNMA the “Enron of the Beltway”.

Of course all of this happened before the housing market credit crunch. And FNMA has been cleaning itself up, having hired a new executive team, revamped its board, appointed bright people to its senior management ranks, and Congress has been making a point to hold the company more accountable for its actions.

But all of this has been fairly recent and, I suspect, is still in the process of being ironed out as it takes time to change the culture of any organization; especially one so tremendous as Fannie Mae. So before Congress grants the like of Fannie & Freddie any additional leeway it should make sure they’re up to the task.

Before US taxpayers are really placed at risk.

PHOTO: Slate.com

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