In a carefully worded report to Congress, a federal regulator says government-sponsored Fannie Mae needs to get a better handle on the interest rate risk of its giant mortgage portfolio.
The regulator recommended tighter scrutiny by Fannie's board of directors, stronger internal controls, and better analytical models.
The recommendations are part of an annual report from the Office of Federal Housing Enterprise Oversight that details the results of examinations of Fannie Mae and Freddie Mac.
The report concluded that Fannie Mae's interest risk management is "generally strong," but its description of Fannie's shortcomings is attracting keen attention in Congress, where a House Banking subcommittee is debating the pros and cons of taxpayer backing for Fannie and Freddie.
It is highly unlikely that Congress would withdraw the government's backing, but new limits on taxpayer exposure are possible, experts say.
In an interview Monday, Rep. Richard H. Baker of the House Banking Committee said the regulator's report underscored his concern that Fannie Mae's and Freddie Mac's rapidly growing mortgage portfolios may place taxpayers at risk during times of sustained interest rate hikes.
Rep. Baker's House subcommittee on capital markets, securities, and government-sponsored enterprises which oversees the mortgage agencies. He said his panel would "move very slowly, but very definitively" to ensure that taxpayers would not have to bail out Fannie and Freddie.
As a result of its examinations, the Office of Federal Housing Enterprise Oversight has concluded that:
*Fannie Mae's board "should formalize its guidance on the conduct of interest rate risk management."
*Fannie's "internal controls should be strengthened by establishing an independent review process for certain key functions in the management of the mortgage portfolio, and by completing the documentation of critical functions and processes."
*Fannie Mae should strengthen its analysis of how the mortgage portfolio would respond to large interest movements.
For Freddie Mac, the report only recommended closer monitoring of credit enhancements provided by third parties.
Rep. Baker said he was particularly concerned because Aida Alvarez, the director of the Office of Federal Housing Enterprise Oversight, has told him she cannot predict how Fannie's and Freddie's mortgage portfolios would respond to prolonged stress, until her agency develops risk-based capital standards next year.
In a letter dated May 13, Ms. Alvarez said that until the advent of risk-based capital rules, "we must share your concern that existing enterprise capital may not be sufficiently high."
Rep. Banker said he believes the Office of Federal Housing Enterprise Oversight "is mismatched against very large, technologically superior agencies."
Neither Fannie Mae nor the Office of Federal Housing Enterprise Oversight would elaborate on the conclusions in the annual report, saying they are not permitted to discuss details of examinations. Fannie spokesman David Jeffers did say that he thought the most important point was that, after a nine-month examination, the regulator found "no material issues."
Other observers were divided over the significance of the report. Bert Ely, a consultant, said the report should serve as a "wake-up call" to Fannie Mae. He said the report suggests there are a lot of "informal practices" in the way Fannie Mae is managing interest rate risk.
But Mike DeStefano, managing director of financial institutions at Standard & Poor's, said Fannie Mae's successful management of its portfolio and its earnings during 1994's rate increases shows the agency can manage interest rate risk.
Mr. DeStefano said he thought the Office of Federal Housing Enterprise Oversight simply wanted "an administrative beef-up that sounds like it would be very easy to accomplish."
