Former Regulator: Move On Freddie, Fannie Now
By David S. Hilzenrath
The federal government has the power to put Fannie Mae and Freddie Mac into receivership now and should do so without delay to prevent the mortgage funding giants from digging taxpayers into a deeper hole.
That's the assessment of Armando Falcon Jr., who from 1999 to 2005 headed the agency that oversaw the companies' financial stability.
"I would force the more accurate accounting of their assets and liabilities, and that would show them to be insolvent," Falcon said in an interview.
"The reason you have to do it now is to reduce the cost of resolving the two companies," Falcon said "We know from the savings and loan crisis that forbearance in dealing with insolvent institutions only increases the cost of resolving the failed institutions," he added.
Regulators allowed many deeply troubled savings and loans to continue taking risks in the 1980s, delaying their collapse and making the eventual bailout more expensive, Falcon said.
Today, as home prices decline and foreclosures mount, one of the big questions facing policymakers is what to do with Fannie Mae and Freddie Mac, which provide crucial funding for mortgage lenders.Together, they own or guarantee $5.3 trillion of mortgages and securities backed by mortgages.
The companies have been losing money and their share prices have plummetted this year. Congress recently authorized the Treasury Department to prop them up with unlimited amounts of government loans or investments -- if the companies consent. Such a bailout could cost taxpayers billions and wipe out current shareholders.
A veteran of Washington battles over Fannie Mae and Freddie Mac, Falcon made his comments before the Web site of The Wall Street Journal reported this afternoon that the Treasury was finalizing a plan to shore up Fannie Mae and Freddie Mac. Details of that plan were not known Friday afternoon.
Falcon, now a Washington-based consultant to banks, investment funds and foreign governments, said he has been telling clients that the government will have to take over Fannie Mae and Freddie Mac and that their stock will become worthless.
While much attention has focused on Treasury Secretary Henry M. Paulson Jr.'s options, Falcon focused on the power Congress recently conferred on a new regulator that replaces his old agency, the Office of Federal Housing Enterprise Oversight. The new regulator, named the Federal Housing Finance Agency and headed by OFHEO director James B. Lockhart III, has the authority to put the companies in receivership if any of several conditions are met. Those include the companies becoming "critically undercapitalized" or becoming "undercapitalized" with no reasonable prospect of rebounding.
Falcon said he would put the companies in receivership on a Friday; wipe out all the shareholders, both common and preferred; remove their boards and management; place their bad assets in a separate entity, and reopen the companies on a Monday under government ownership. Backed by the full faith and credit of the government, they could borrow money at lower interest rates and pass that savings to consumers, Falcon said.
Though the Treasury would need the agreement of the companies to intervene, the agency can act unilaterally, Falcon noted.
Fannie Mae, based in the District, and Freddie Mac, based in McLean, have said they don't need government intervention. In a recent appearance on the Diane Rehm Show, Fannie Mae chief executive Daniel H. Mudd was asked "how in the world" he can make up the lost stock value. "Well, we're going to make that up by continuing to operate the business," he said.
Fannie Mae and Freddie Mac "will never agree to get taken over and will string [Paulson] along until a new administration takes office," Falcon said by e-mail.
Spokesmen for Fannie Mae, Freddie Mac and Lockhart declined to comment for this story.
Falcon, a Democrat, worked on savings and loan issues as a member of the House Banking Committee staff. He faced criticism in 2003 when, shortly after OFHEO gave Freddie Mac a favorable review, the company disclosed major accounting problems. Falcon later initiated a probe of Fannie Mae's accounting, which found that the company flouted rules to inflate profits and bonuses.
Though some Fannie Mae supporters in Congress denounced him for making such accusations, the company ultimately admitted it had overstated profits by $6.3 billion and reached a $400 million settlement with the Securities and Exchange Commission.
In interviews this week, Falcon took issue with the companies' current accounting, saying they have taken only small writeoffs in relation to their billions of dollars of paper losses on mortgage-related investments. The companies have refrained from taking a larger hit on the grounds that they expect the investments to recover their lost value.
"At some point the notion that their assets are only temporarily impaired becomes a fiction and a fraud," Falcon said. "If we're not there, we're approaching it very, very soon."
Peter Wallison of the American Enterprise Institute, a longtime critic of Fannie Mae and Freddie Mac, said he doesn't think it is clear that either of the companies is critically undercapitalized, but he said a regulator's first instinct is to keep an institution alive and functioning. In the world of perceptions, "if a regulator has to declare that one of his charges has failed, that means the regulator has failed," Wallison said.
Freddie Mac recently reported that, if it liquidated its assets and liabilities at their values as of June 30, it would have been left with a negative $5.6 billion. That disclosure could give the regulator additional grounds to put the company in receivership, Falcon said. Under the new law, the regulator can do so if the company's assets are less than its obligations.
Accounting specialists interviewed for this story said there are other ways of comparing assets to obligations that would lead to a different conclusion.
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