Fannie and Freddie Polish Image
With Subprime-Loan Purchases

Freddie Mac and Fannie Mae said they expect to buy tens of billions of dollars of newly created subprime mortgage loans over the next few years to help prop up the roughly $1.3 trillion subprime market as lenders tighten their credit standards or flee altogether.

The move shows how the two government-sponsored companies are redeeming themselves on Capitol Hill by depicting themselves as part of the solution to surging defaults on subprime mortgages, those for borrowers with weak credit records or high debt in relation to income.

The promises to help such borrowers are bolstering their support in Congress just as lawmakers debate legislation to tighten regulation of Fannie and Freddie, both emerging from accounting scandals. That makes it less likely that Congress will back longstanding calls from the Federal Reserve and others for tight constraints on the amounts of mortgages they can retain as investments, currently around $1.4 trillion, or 14% of U.S. home loans outstanding.

Congress has grown increasingly worried in the past few months that rising defaults on subprime loans will soon lead to a record wave of foreclosures, depriving hundreds of thousands of families of their homes. That worry has overshadowed earlier warnings from the Bush administration that Fannie and Freddie, chartered by Congress to support the housing industry, had grown so large that they could set off a financial crisis if they fail to manage their interest-rate risks correctly.

Rep. Barney Frank (D., Mass.), the chairman of the House Financial Services Committee, said at a hearing on subprime problems Tuesday that the companies' capacity for buying and holding mortgages is proving useful. That, he said, undercuts the notion that their mortgage holdings "are this 'bad thing.'"

Fannie and Freddie buy loans from lenders and package them into securities, held in their own portfolios or sold to investors world-wide. Neither company has been a significant direct buyer of subprime loans. Instead, they have bought AAA-rated portions of subprime-mortgage securities packaged by Wall Street firms.

Yesterday, however, Freddie's chairman and chief executive officer, Richard Syron, said the company plans to buy over several years $20 billion of subprime loans to be held on its portfolio. Fannie had said Tuesday that about 1.5 million homeowners who face potential "payment shocks" as rates on their mortgages adjust may be eligible for refinance loans that Fannie could buy. A Fannie spokesman said yesterday it isn't clear how many such loans will be available for Fannie to purchase in the next few years but that "we're probably looking at tens of billions of dollars."

This more direct participation in the subprime market may encourage lenders to make more money available to people with weak credit records who want to buy homes or refinance out of adjustable-rate loans on which payments rise steeply after an initial two- or three-year period of relatively low, fixed-rate payments.

The Fannie spokesman said his company already is buying subprime loans under a recently announced plan to help troubled borrowers. Freddie's Mr. Syron said in an interview that his company has been consulting with major lenders and is likely to start buying subprime loans in July. One goal, he said, is to encourage lenders to offer loans that will prevent sudden leaps in payments after just two or three years.

"I suppose [the plan] doesn't hurt" the companies' relations with Congress, Mr. Syron said in an interview. "Believe it or not, we didn't do this for that reason....This is what we should be doing."

Mr. Syron and Fannie's CEO, Daniel Mudd, appeared in Congress yesterday at a "homeownership preservation summit" convened by Sen. Christopher Dodd (D., Conn.) "I applaud what Freddie is doing, and Fannie," Mr. Dodd said. "I commend them for coming in this morning with very concrete ideas."

Such praise represents a reversal of fortune for the two companies, which seemed to be on the ropes two years ago as public outrage over their accounting scandals emboldened the Bush administration to demand that they shed most of their mortgage holdings.

Despite this improved atmosphere, Fannie and Freddie can't rev back up to their racy growth of the 1990s and early part of this decade. At least until they can get their books fully in order, which is likely to take another year or two, regulators will keep tight constraints on their growth. But, at least for now, Fannie and Freddie have averted the threat of being turned into much smaller companies and are better positioned to promise their shareholders a return to long-term growth.

Part of this turnabout is luck. If Fannie and Freddie had to have accounting scandals, they picked the perfect timing, just as the housing market was heading into a speculative binge fueled by aggressive mortgage lending. Those accounting woes forced Fannie and Freddie to reduce their loan purchases when the market was lowering credit standards on subprime mortgages. So other investors, as well as lenders, ended up with most of the worst loans and will absorb the bulk of the losses.

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