Mortgage giants Fannie Mae and Freddie Mac could pose a threat to the financial system in the US if their debt is not restrained, Federal Reserve Chairman Alan Greenspan said Tuesday, urging Congress to consider capping the debt the two companies can carry.
Greenspan said that the two institutions have grown to be among the nation's largest financial institutions and now stand behind US$4 trillion of home mortgages, or more than three-fourths of the single-family mortgages in the US.
Greenspan said he believed both institutions have managed their financial risks well to date, but he said that he believed risks would rise if the two institutions allowed their debt levels to grow in the future without any restraints.
He said that "future systemic difficulties" could be considered likely and he urged Congress to take action "sooner rather than later."
With his testimony before the Senate Banking Committee, Greenspan put his considerable influence on financial matters behind a growing effort to overhaul the two institutions, which financial competitors contend have become too big and now threaten the security of the financial system.
Fannie Mae and Freddie Mac, the two biggest players in the multitrillion-dollar home mortgage market, have come under increased scrutiny since an accounting crisis at Freddie Mac came to light last spring. Freddie acknowledged that it had understated earnings by US$5 billion for 2000 through 2002.
In his testimony, Greenspan said it would not be enough for Congress to simply establish a new regulatory body if this regulator was not given adequate regulatory powers to deal with such issues as the implicit guarantees these institutions are believed to have from the federal government.
Greenspan said this implicit guarantee clearly existed in the minds of investors even though there is an explicit statement in the debt issued by the two institutions that they are not backed by the full faith and credit of the US government.
Despite this statement, Greenspan said, "most investors have apparently concluded that during a crisis the federal government will prevent the [institutions] from defaulting on their debt."
This perceived government guarantee has allowed both institutions to borrow at lower interest rates. The two institutions contend that they pay these savings on to home buyers in the form of lower mortgage rates.
But Greenspan cited a recent Fed study that found that only a small portion of this subsidy was passed on to home buyers and the far bigger portion of the subsidies, in the billions of dollars, was passed on to the stock holders of Fannie and Freddie, which are both publicly traded companies.
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