For many community bankers, a piece of legislation that the House Banking Committee quietly approved before its August recess is more important than the familiar banking reform bill.

Yet on H.R. 2900, mandating regulation of government-sponsored enterprises, the committee received no input from the financial community.

As a result, the committee adopted an approach to regulating the Federal National Mortgage Association and Federal Home Loan Mortgage Corp. written largely by lawyers for the two institutions.

Two years and five studies after the committee rejected an amendment I offered to require risk-based capital standards for Fannie Mae and Freddie Mac, the banking committee has approved an approach that in effect would perpetuate the regulatory status quo.

Enormous Growth

Government-sponsored enterprises have more than $980 billion in obligations that are implicitly guaranteed by the federal government. The securities of Fannie Mae and Freddie Mac make up three-quarters of these obligations.

At the end of 1990, the two corporations had financed nearly $470 billion in mortgages, more than 2.5 times the level at yearend 1985. The growth is attributable to the fact that savings and loans encountered solvency and liquidity problems and that Fannie Mae and Freddie Mac have become two of the most leveraged institutions on the financial landscape.

There is little doubt that in the past decade, and particularly in the past few years, Fannie Mae and Freddie Mac have helped keep interest rates down and making the home lending market more liquid. But the future may not mirror the past.

Birth of a Duopoly

Governmental institutions designed to service the private sector by packaging loans for resale to a secondary market have overnight become the biggest primary-market competitors of the institutions they were created to help. Fannie Mae alone holds over $120 billion of mortgages in its own portfolio.

The danger is real that the duopoly of power Fannie Mae and Freddie Mac developed in the secondary financing market at the beginning of this decade will become a duopoly of direct mortgage holding by the beginning of next year.

It is the very success of Fannie Mae and Freddie Mac that puts their competitors and thus the taxpayers at risk.

Under law, government-sponsored enterprises can take advantage of higher leveraging ratios and lower taxes and funding costs. As these benefits cause thrifts to lose market share, the liabilities of the S&L industry increase.

The cost of the S&L bailout -- now projected at $500 billion -- could explode further if thrifts are not allowed to compete equitably in the one market they were created to serve.

Capital Lenience

As the 1980s taught us, prudent capital ratios are critical. In addition to putting a cushion between an institution's liabilities and the taxpayer's pocket, sound ratios ground institutional decision-making in less risky behavior. And a level playing field can be established only if there are level capital ratios.

It is noteworthy that the House Banking Committee established maximum, rather than minimum, capital standards for housing's two government-sponsored enterprises -- 2.5% for on-balance-sheet assets and 0.45% for off-balance-sheet assets. Also, for regulatory purposes the committee defined loan-loss reserves as capital. All this would apply in three years.

Fortunately, both of the housing government-sponsored enterprises are well run today. But Congress must understand that if interest rates had gone up rather than down in the 1980s, Fannie Mae would be the single largest institutional liability that the U.S. government would ever have been forced to oversee.

Proposals for Reform

Congress must decide whether to maintain the legal status quo and competitive advantages of Fannie Mae and Freddie Mac or fully privatize them.

To focus the review, this summer I offered a series of amendments. They would increase capital requirements on Fannie Mae and Freddie Mac and repeal many of their special benefits, including:

* Lines of credit with the Treasury.

* Exemptions from federal securities law and state taxes.

* Provisions letting the obligations of government-sponsored enterprises be accepted as security for public funds.

The Treasury has estimated that these benefits give the equivalent of $2 billion to $4 billion in annual taxpayer subsidy.

Also, these behemoth government-sponsored enterprises need not meet the same Community Reinvestment Act standards as commercial banks and thrifts. Though their priveleged status benefits their stockholders, it reduces credit availability in poorer neighborhoods - because as the market share of government-sponsored enterprises increases, the market share of institutions that have to meet CRA standards decreases.

Tarnished Advice

Unfortunately, the committee's judgment in the housing provisions of H.R. 2900 was clouded by putative consumer group's endorsement of the approach favored by Fannie Mae and Freddie Mac.

Those groups, which did not acknowledge conflicts of interest, tarnished their reputations by accepting well-timed contributions from the two government-sponsored enterprises.

In fact and in deed, Fannie Mae and Freddie Mac are beginning to seem like an arrogant, two-headed monopoly controlling 90% of the market.

Fear of Reprisals

Such market dominance allows for heavy-handed approaches to competitors, financial intermediaries, and consumers.

Competitors such as community-based thrifts and commercial banks are also users of the services of government-sponsored enterprises. They are understandably apprehensive about expressing reservations about the enterprises practices, for fear of retaliation.

Likewise, would-be competors such as securities firms run market risks if they object or attempt to compete with Fannie Mae and Freddie Mac because they have a reputation of not cottoning to challengers of the status quo.

Paying the Price

As for the consumer sector, market dominance allows price latitude, if not manipulation.

Earlier this year, for instance, both enterprises raised the fees they charge for guaranteeing mortgages.

The increases came despite impressive profits. Fannie Mae earned $1.2 billion last year and managed to provide its departing chairman with a $27 million retirement package.

Such profit capacity and such arrogance underline the need for more private-sector competition and more public scrutiny.

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