Congress ignores threat to banking system

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(San Diego) UNION-TRIBUNE EDITORIAL

Super scandal

Congress ignores threat to banking system

July 10, 2006


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Fannie Mae and Freddie Mac.. formed under a federal charter after the Great Depression, the corporations made home ownership possible for millions of families. For decades, their main job was to inject cash into the mortgage lending business by setting credit standards and pooling individual loans into bonds for sale to investors around the world. But during the 1990s, after intense lobbying in Congress, the firms began to abuse their charters. Instead of merely creating mortgaged-backed securities, they began holding mortgages themselves, quickly building vast portfolios upon an enormous pile of borrowed money. The key was investor confidence that taxpayers would bail out the companies in a crisis, allowing Fannie and Freddie to borrow at lower interest rates than competitors. Fat profits ensued as the two giants used short-term credit to buy 30-year mortgages paying higher rates.

Still, mortgage lending can be risky, as any 1980s savings and loan executive could tell you. So Fannie and Freddie have hedged their considerable risk with a variety of exotic, unregulated financial instruments called derivatives or interest-rate swaps. Particularly worrisome is that banks around the globe hold these derivatives. Alan Greenspan and his successor at the Federal Reserve, Ben Bernanke, call this “systemic risk,” a nice way of saying that a mortgage giant meltdown, probably caused by rapid swings in interest rates, threatens the international banking system.

If that wasn't frightening enough, evidence is piling up that Fannie and Freddie have been mismanaged for years. Fannie recently agreed to pay $400 million in fines after hiding $10.6 billion in losses. Executives manipulated earnings for millions in bonuses. Meanwhile, Freddie confessed to raising $1.7 million for political candidates. Such fund-raising is explicitly banned by federal law. Such abuses were entirely predictable. For years the two have poured cash into lobbying Congress to gain protected status.

President Bush could emerge as the hero of this story. He's been pushing the companies to sharply reduce their debt portfolios. Entirely ignored by the Republican Congress, the president appears to have determined that the Treasury can shrink the giants without new legislation. The president must beat Congress on this one. The crisis feared by Greenspan makes the $200 billion savings and loan debacle look like a Sunday picnic.


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