Just How Risky Are Fannie and Freddie?

For years large commercial banks have urged Congress to rein in the galloping growth of mortgage-finance giant Fannie Mae and its smaller cousin, Freddie Mac. So far the two government-chartered, shareholder-owned companies have fought off efforts to restrain them. But the “too big, too risky” refrain grew louder in the past year as Federal Reserve Chairman Alan Greenspan and Treasury Secretary John W. Snow added their voices to the chorus. They advised Congress to put Fannie and Freddie under Treasury’s oversight and let regulators set capital standards — a backdoor way to limit the housing giants’ growth.

Not everyone is as worried as Greenspan and Snow — particularly R. Glenn Hubbard, President George W. Bush’s former chief economist. In a 33-page study that Fannie Mae commissioned and made available to BusinessWeek before publication, Hubbard, who now heads the Columbia Business School, argues that Fannie is no riskier than the 10 largest commercial banks or their holding companies. Hubbard also concludes that Fannie’s capital reserve — the cushion that financial institutions need in case of emergency — is adequate.

Why does this matter? Fannie Chairman and CEO Franklin D. Raines will use the report to rebut critics who charge that Fannie’s low borrowing costs represent an implicit federal subsidy created by debtholders’ confidence that the government will rescue them in a financial crisis. Hubbard’s work will bolster Raines’ argument that Fannie has a cost advantage because it’s low-risk. In the study’s foreword, Raines writes that Hubbard “confirms the low-risk nature of Fannie Mae’s business but also…indicates a fundamental flaw in studies that purport to quantify an ‘implicit subsidy’ to the company.” Hubbard says: “That’s Frank Raines’s view.”

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