Despite assurances to the contrary, a growing group of skeptics said Wednesday that they expect the Treasury Department to use the unprecedented power Congress is poised to give it over Fannie Mae and Freddie Mac.
The House passed a bill 272 to 152 that would give the Treasury the authority to make unlimited equity and debt investments into Fannie and Freddie. The Senate is expected to follow suit soon.
"My gut reaction would be that the Treasury secretary does intend to use the authority," said Rep. Michele Bachmann, R-Minn., a member of the House Financial Services Committee, who voted against the bill.
Andrew Parmentier, the managing director for equity research at Friedman, Billings, Ramsey Group Inc.'s FBR Capital Markets, concurred with that assessment.
"I don't buy into the notion that it is purely standby authority, and that their true intention is not to use it," he said.
The Treasury's new powers are tied to a broad housing package that would create a new regulator for the government-sponsored enterprises, modernize the Federal Housing Administration, and allow it to back underwater mortgages after lenders write down the principal.
But the last-minute provisions designed to help backstop Fannie and Freddie have become the most controversial.
Key lawmakers say they believe Treasury Secretary Henry Paulson, who has repeatedly said he does not expect to use the enhanced authority, because its very existence would restore market confidence to the GSEs. The bill also includes language that would make the authority expire Dec. 31, 2009.
But several observers argue that Mr. Paulson may soon have to use the authority, and that they expect it to be extended before it sunsets next year.
"It will be hard" to phase out the guarantee, said Lawrence White, a professor at New York University's Stern School of Business. "It will probably require explicit legislation by the end of '09 to do whatever the Congress and the new administration sees fit to do. Without any legislation, my guess is … the explicit guarantee will remain in place."
Rep. Tom Price, R-Ga., said he did not know "how Congress ever steps back and removes" the Treasury authority. "There will be the argument that if we don't continue this authority, then the markets will shudder and shake, and so I believe this will be permanent."
The only independent analysis has come from the Congressional Budget Office, which said Tuesday there was a better than 50% chance that the new authority would never be needed. That analysis did little to calm anxious conservatives, who say taxpayers are now explicitly on the hook for problems at Fannie and Freddie.
"Let's go to the doctor, and the doctor says to you, 'Well, there's a 50% chance that you're healthy, and there's a 50% chance that you are not,'" said Rep. Randy Neugebauer, R-Tex., who spoke on the House floor during debate Wednesday. "That would not be very reassuring to the patient, and it certainly should not be very reassuring to the American taxpayers, particularly when the CBO says it is not clear what criteria the Treasury would use to provide this assistance to the GSEs."
Though the CBO estimated the bill would cost the government $25 billion, it also said there was a 5% probability the price tag could quadruple.
It's clear that if the Treasury were forced to use the authority, there would be a price for the GSEs. House Financial Services Committee Chairman Barney Frank, D-Mass., has said that Fannie and Freddie would be put into receivership before the Treasury would invest in them directly.
Other observers agreed with that prediction.
"It's one of the many scenarios out there, but it is one of the most possible probable ones," said Karen Shaw Petrou, managing director of Federal Financial Analytics Inc. "Absent the receivership, Treasury would be enriching current shareholders, and I would suspect it would be reluctant to do so, other than in a market emergency where that was deemed necessary."
Whether observers predict that the Treasury would need to step in depends almost entirely on whether they believe the assurances of Fannie, Freddie, and their regulator that the two GSEs are well capitalized.
"It depends on the extent to which they have holes in their balance sheets," said Thomas Stanton, a fellow of the National Academy of Public Administration.
But using the Treasury's power could trigger more panic in the markets — a scenario that likely would dissuade the department from seeking to use it, Mr. Stanton said. "The backstop would be most valuable in giving Fannie Mae and Freddie Mac some breathing room to go to the capital markets and try to raise money on the equity side, which is really what they need to do," he said. "If Treasury needs to use its backstop authority, there is a possibility that the markets will become more frightened rather than less."
But a few argued that the Treasury may act regardless of the true economic conditions at Fannie and Freddie. The Bush administration has sought to rein in the GSEs for several years, and investing in their equity or buying up their debt would give them more power to do so. (In both cases, the investments must be approved by the GSEs themselves.)
The Treasury is planning to use the new power, "though not necessarily because of Fannie and Freddie's financial situation," said Joseph Mason, a finance professor at Louisiana State University. "The reason to use it is more political than economic."
Supporters of the bill, however, said they do not doubt Mr. Paulson's intentions.
Senate Banking Committee Chairman Chris Dodd, D-Conn., and Sen. Richard Shelby of Alabama, the panel's No. 1 Republican, argued that the Treasury was unlikely to act. They said just knowing the Treasury could step in would reassure nervous investors.
"I don't believe, based on what I've been told by Secretary Paulson, that they have any intention to use this authority, but taking this implicit guarantee to a more explicit one will have some real value," Sen. Dodd said. Mr. Paulson "has stated over and over again the last thing he wants to do is to exercise the authority we will be giving him in this legislation."
Passage of the legislation is virtually assured. The White House dropped its veto threat Wednesday morning, saying the overall bill is too important for the housing market. The administration had threatened a veto because a provision would allocate $4 billion of funds to let states and localities repurchase foreclosed properties.