Does Alan Greenspan Love Banks or What?

When contemplating GSE reform, here's an interesting question to ponder: If Fannie Mae and Freddie Mac pose a systemic risk to the U.S. financial system because they own $1.4 trillion in mortgage assets, then how come the nation's top five banks - which hold trillions of dollars in derivatives - do not?

Federal Reserve chairman Alan Greenspan wants Congress to cap Fannie and Freddie's mortgage holdings at $100 billion each for a total of $200 billion.

If Mr. Greenspan gets his way, that means the two GSEs would have to unload, over time, about $1.2 trillion in MBS and whole loans. At $1.4 trillion (on-balance sheet), Fannie and Freddie account for just 15.6% of all outstanding home loans in the U.S.

But according to Sen. Paul Sarbanes, D-Md., the ranking minority member on the Senate Banking Committee, some 95% of all notional derivatives are concentrated at the nation's top five banks. How much in derivative contracts do banks hold? About $55 trillion - with a "T."

During congressional hearings, Sen. Sarbanes noted that federal banking regulators do not have the authority to limit the growth of commercial banks, suggesting that if Fannie and Freddie should have asset limits then maybe so, too, should banks.

One investment banker we spoke with - a Republican who has an open mind about the GSEs - believes that if FanFred's holdings were capped at $200 billion, banks would be the obvious buyers of their discarded MBS and would control not just the mortgage industry (which they sort of control now) but could, in effect, control liquidity in the housing finance market.

I might add, as an aside, that if you can control liquidity - and bond prices - then you can control interest rates. You might think "the market" determines rates. That's correct - but thanks to the death of Glass-Steagall, who is the market? Answer: banks.

The volleying over GSE reform and what caps (if any) will be placed on FanFred is just beginning.

Based on public comments he's made thus far, it's safe to assume that the central banker is no fan of the GSEs - but it's also safe to assume that he apparently thinks the world of commercial banks. Why Mr. Greenspan thinks banks are so great is another question.

The deposits that banks offer to consumers are insured by the federal government via the Federal Deposit Insurance Corp. Fannie and Freddie's bonds and MBS carry no full-faith-and-credit guarantee even though the entire world - especially Wall Street - thinks Uncle Sam will step up to the plate should a crisis occur.

How much in deposits does the FDIC insure at commercial banks? At last check it was $4 trillion-plus. Now, isn't the FDIC laying off staff left and right? That's correct. So, while banks continue to grow in size - and their derivatives continue to grow - there will be less cops on the beat.

Fannie and Freddie haven't exactly distinguished themselves the past two years. Both have been embroiled in complex accounting scandals that resulted in their top executives getting canned and their regulator combing their books with a fine-toothed comb.

What OFHEO found at FanFred wasn't pretty. Freddie was earning so much money that it felt compelled to hide some for a rainy day - $5 billion worth. Fannie played accounting games so its politically connected executives could make their bonus goals and please Wall Street. Fannie, though, overstated earnings by $10 billion from 2001 to 2004.

Here's another question to ponder: If the FDIC, the Federal Reserve and the OCC combed the books of the nation's top 20 banks, would regulators uncover the same accounting crimes found at FanFred? Would their derivatives hold water? Are the "counterparties" on the other side of those derivatives healthy?

Paul Muolo is executive editor of Mortgage Servicing News and National Mortgage News. He can be e-mailed at Paul.MuoloSourceMedia.com.

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