Freddie and Fannie have grown so large that they have the potential to disrupt the entire financial system should either get into real trouble. They own or guarantee about 42% of the nation's $7 trillion home-mortgage market. Freddie alone owns or insures $1.29 trillion of home mortgages. A few months ago, William Poole, president of the St. Louis Federal Reserve Bank, warned that the "enormous scale of [their] liabilities could create a massive problem in the credit markets" and that "a market crisis could become acute in a matter of days, or even hours."
Yet Freddie and Fannie are not regulated by the Office of the Comptroller of the Currency, which regulates national banks, or the Federal Reserve, which looks after the overall financial system. Nor are they required to make the same disclosures as banks. They are supervised by the Federal Housing Enterprise Oversight Office, a branch of the Housing & Urban Development Dept. And FHEOO is not up to the job. Freddie and Fannie are major players in the derivatives market, which they use to hedge their interest-rate risks. Right now, no one knows if Freddie manipulated its earnings for three years, inadequately hedged its exposure to unexpected interest-rate changes, or otherwise put the financial system in harm's way. Answers are needed quickly.
The larger question is whether Freddie and Fannie are truly government enterprises backed by the full faith and credit of Uncle Sam. Buyers of their mortgage-backed securities assume an implicit government guarantee and price their paper accordingly. But Washington has never put Freddie's and Fannie's obligations on its own books. It should. Or it should privatize the two corporations -- which already trade publicly -- and their debt. This would probably increase the cost of mortgages.
Tightening the regulatory oversight of Freddie Mac may prove difficult. It was one of the top 10 soft-money contributors to political parties in the 2002 Presidential and congressional elections. It has a lot of friends in Congress. But the risks to the nation's financial system are too great for legislators to avoid their responsibility. Freddie and Fannie are giant financial institutions that need to be supervised by regulators -- the Fed, the Comptroller, or the Treasury -- that know what they are doing.