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White House Could Use Back-End Route to Limit GSE Debt

The Bush administration is threatening to control the debt issuance of Fannie Mae and Freddie Mac - indirectly limiting their portfolio growth - if Congress does not pass strong GSE regulatory reform legislation.

The Treasury Department has maintained for some time that it has the legal authority to regulate the two government-sponsored enterprises' issuance of corporate debt, which is mainly used to finance their massive portfolios.

A recent report by the Office of Federal Housing Enterprise Oversight alleging massive accounting fraud at Fannie has prompted the administration to raise the stakes in its effort to break a congressional stalemate over GSE legislation.

GSE supporters claim the administration is playing politics, using all its powers to secure passage of a bill that empowers a new regulator to limit or reduce the size of Fannie and Freddie's portfolios, which combined have $1.45 trillion in assets.

"They are attacking from all sides with every gun they have. This is a political effort," said Jerry Howard, executive vice president and chief executive of the National Association of Home Builders.

Treasury undersecretary Randal Quarles served notice last week that his staff is reviewing its approval process for debt issuance in light of the accounting scandals at the two GSEs and continued weaknesses in their accounting systems, risk management practices and internal controls.

"The time is right for Treasury to review its debt approval process to ensure that we continue to act as appropriate custodians of the power that Congress gave us when the charters of Fannie Mae and Freddie Mac were created," Mr. Quarles told a Women in Housing and Finance meeting.

Also last week, the Department of Housing and Urban Development announced a review of Fannie and Freddie to see if some of their investments are inconsistent with their housing mission.

"The department will soon initiate a review of Fannie Mae and Freddie Mac investments and holdings, including certain equity and debt investments, with a focus on transactions classified on their financial statements as 'other assets/other liabilities,'" HUD secretary Alphonso Jackson said.

"Other assets" listed on their balance sheets is a catchall phrase for short-term holdings of non-mortgage-related investments. Sometimes, these investments include short-term corporate debt or equities that clearly are not tied to their housing mission. (A few years back, Freddie Mac was criticized for investing in debt obligations issued by tobacco giant Philip Morris.)

The last time the two filed annual financial reports, Fannie listed $26.4 billion in other assets (year-end 2003) and Freddie $5.7 billion.

Secretary Jackson complained about a lack of disclosure and transparency surrounding these investments in a speech to a congressional caucus.

The two GSEs said they will cooperate with reviews. "We'll work with Treasury and HUD and cooperate with the reviews," Fannie spokesman Brian Faith said.

In his speech, the Treasury undersecretary reaffirmed the Bush administration's support for a GSE reform bill (currently in pending in the Senate) that includes strong portfolio limits.

Senate Banking Committee chairman Richard Shelby, R-Ala., is pushing for a vote on the Senate bill (S. 190) before August, but he doesn't appear to have the votes to overcome opposition from Senate Democrats.

Mr. Quarles indicated that Treasury prefers a legislative solution to the portfolio problem as opposed to acting unilaterally.

At the same time, the Treasury official pointed out that Fannie has reduced its portfolio by nearly $200 billion over the past year - and with no discernable impact in the housing market. It appears "further shrinkage" would have little impact, Mr. Quarles said.

Mr. Howard expressed concerns the administration's stance could hurt the housing market, which he said is already in the midst of "natural slowdown." He said Sen. Shelby needs to work out a compromise with his counterparts in the House, who have passed an acceptable GSE bill. "We would rather have the status quo than a bad bill. And the Senate bill is a bad bill," Mr. Howard said.

Friedman Billings Ramsey equity analyst Paul Miller warned investors that regulatory pressure to rein in the two's investments is increasing. However, Mr. Miller says in a report that Treasury's authority to limit the GSEs' debt has never been tested. "We believe Treasury is unlikely to use this tool."

Freddie spokesman Sharon McHale said, "Since we have not seen any specific proposal to change that process, it would be speculative to comment." She added, though, that Treasury and Freddie have developed a "very efficient process for requesting and obtaining approval to issue our debt. It has worked extremely well."

Despite their announcement last week, Treasury officials maintain they have not set a specific deadline or timetable for completing the review. "We don't expect it will take an extremely long time," Mr. Quarles told reporters. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com