July 13, 2008 Long Protected by Washington, Fannie and Freddie Ballooned
By JULIE CRESWELL
As the Bush administration scrambles to address the sudden decline of the country’s two largest mortgage finance companies, some of their longtime critics say the crisis has been building for years.
Among them is Jim Leach, a Republican former representative from Iowa, who began arguing two decades ago in Congress that the government-chartered mortgage companies, Fannie Mae and Freddie Mac, were unfairly insulated from the real world.
They were not subject to the same financial standards and tax burdens as their competitors, he warned, and if they ran into trouble, an implicit government guarantee to back them up meant taxpayers would be left with the losses.
“There are times in public policy making that one can feel like Don Quixote,” Mr. Leach said of his repeated legislative battles to rein in the two companies’ growth.
Congress established Fannie Mae during the New Deal to make homes more affordable for lower- and middle-income Americans, and Freddie Mac was established later with a similar purpose. Neither provides home loans. Instead, the companies buy mortgages from banks and take on the risks of possible defaults — allowing banks to make even more mortgages.
Today they own or guarantee about half of the country’s $12 trillion in mortgage debt, so the free fall of their share prices last week amid concerns that they were undercapitalized has created chaos for Wall Street and Washington.
The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.
In Washington, Fannie and Freddie’s sprawling lobbying machine hired family and friends of politicians in their efforts to quickly sideline any regulations that might slow their growth or invite greater oversight of their business practices. Indeed, their rapid expansion was, at least in part, the result of such artful lobbying over the years.
And as Fannie and Freddie grew, so did the fortunes of Wall Street, which reaped rich fees from issuing debt for the two companies, as well as the mortgage and housing industries, which banked billions of dollars as the housing market boomed.
Even after accounting scandals arose at the two companies a few years ago, attempts to push through stronger oversight were stymied because few politicians, particularly Democrats, wanted to be perceived as hindering the American dream of homeownership for the masses.
Lots of perks came with Fannie and Freddie’s charters and government backing: exemptions from state and federal taxes, relatively meager capital requirements, and an ability to borrow money at rock-bottom rates.
James A. Johnson, a longtime member of the Washington establishment who previously worked as a campaign adviser to former Vice President Walter F. Mondale, ran Fannie for most of the 1990s.
“Jim Johnson was the architect of Fannie’s lobbying strategy. He was the muscle guy, if you will. The guy who would walk the halls of Congress,” said Bert Ely, a banking consultant in Arlington, Va., and longtime critic of the companies. Freddie, Mr. Ely said, soon copied Fannie’s playbook.
Mr. Johnson could not be reached for comment. Fannie declined to comment; Freddie did not respond to an interview request.
An early, and for some analysts, seminal attempt to overhaul regulation of Fannie and Freddie occurred in the early 1990s when the country was still licking its wounds from the savings and loan debacle.
As legislators debated who would regulate Fannie and Freddie and what sort of capital cushions should be established for the entities, the companies enlisted a bipartisan mix of Washington insiders to represent them.
Fannie and Freddie were careful to include powerful Democrats and Republicans as executives, board members and lobbyists to make sure they had access to top government officials and clout on Capitol Hill, no matter which party was in power.
The strategy that started two decades ago continues. They have hired many officials who have worked for the last two administrations alone. Fannie hired Jamie Gorelick, a former deputy attorney general in the Clinton administration; Thomas E. Donilon, who was that administration’s chief of staff to the secretary of state; and Franklin D. Raines, who was President Clinton’s budget chief.
Among Republicans, Fannie hired Robert B. Zoellick, now the head of the World Bank and a former official in both Bush administrations; Stephen Friedman, the onetime top economic adviser to the current President Bush; and Michele Davis, now an assistant secretary of the Treasury under Henry M. Paulson Jr.
Fannie’s board once included Frederic V. Malek, a longtime friend of the Bush family and a former business partner of the current President Bush.
The outcome of the regulatory tussle in the early 1990s did little to change things. Fannie and Freddie got a new but fairly weak regulator, the Office of Federal Housing Enterprise Oversight, while still having to meet less onerous capital requirements than some lawmakers wanted. The companies also stymied efforts to get the Securities and Exchange Commission more actively involved in regulating them.
Later on, Mr. Johnson ramped up the influence of its charitable arm, the Fannie Mae Foundation, by doling out money to thousands of nonprofit groups and similar organizations. (Mr. Johnson was compelled to step down as the head of Senator Barack Obama’s vice-presidential search team last month after he was criticized for receiving mortgages on favorable terms from Countrywide Financial.)
Fannie and Freddie also forged alliances with various interest groups, including affordable-housing advocates that previously criticized the companies for not doing enough for low- and middle-income homeowners.
Mr. Leach, the Iowa representative, later accused Fannie and Freddie of effectively buying off activist groups by making charitable contributions to them. By providing much-needed grant money to the nonprofit groups, it made it hard for them to criticize the mortgage titans, said Jonathan GS Koppell, an associate professor at the Yale School of Management.
“Likewise, there were another set of entities, essentially a huge industry, that profits from every additional loan that Fannie or Freddie can buy,” Mr. Koppell said. “The more loans they purchase, the more business there is for them and so they’re willing to work with the enterprises.”
Fannie also opened up what it called Partnership Offices. They were billed as regional oversight offices for various housing projects financed by Fannie. In reality, critics, including the Department of Housing and Urban Development, said they were used primarily to influence Congress by providing local politicians and business leaders with ample ribbon-cutting ceremonies and photo opportunities.
The offices were often run by and populated with former Congressional staff members. Several of those offices were staffed by family members of legislators, said Joshua Rosner, an analyst at Graham-Fisher in New York.
Of course, foes of Fannie and Freddie began their own lobbying efforts, the most muscular of which had the backing of banks eager to get their own piece of the companies’ lucrative mortgage business.
Some Wall Street firms joined these efforts, but they typically did not push too hard over fears that Fannie might retaliate by withholding business — and the rich fees associated with it.
From 1990 to 2000, as each company’s stock grew more than 500 percent and top executives earned tens of millions of dollars, much criticism appeared on opinion pages of newspapers, in reports by free-market research groups and in Congressional testimony. Much of it was sponsored by a loose coalition of Washington lobbyists and consultants who were paid to portray Fannie and Freddie as too big and risky.
Ultimately, what most hurt the companies was the failure of home buyers to pay off subprime and other risky mortgages that were packaged into bonds and sold to investors by Wall Street banks like Bear Stearns, Lehman Brothers and Citigroup, with Fannie and Freddie playing a lesser role. But they are suffering from the reverberations of the foreclosure wave, as the value of their mortgage assets declines along with home prices everywhere.
Supporters of Fannie and Freddie say the companies’ lobbying machines have largely been taken apart in the wake of the accounting scandals, which resulted in billions of dollars of financial restatements and the ouster of major executives. Fannie’s Partnership Offices have been closed and its charitable foundation shut down.
Critics say that current housing legislation before Congress could give even more power to Fannie and Freddie by allowing them to venture into new mortgage-related businesses. That, they say, is evidence enough that the companies have not been fully defanged.
At the same time, the Senate version of that legislation, which was passed overwhelmingly on Friday, would also create an independent regulator to oversee Fannie and Freddie.
“For sure, the political machine has not been dismantled,” said Thomas H. Stanton, a finance professor at Johns Hopkins University. “For every interest that might lose if Fannie and Freddie expands into what it does, you have someone else who wants to do business with them.”