Home mortgage giants Fannie Mae and Freddie Mac got lumps of coal -- not goodies -- in their holiday stockings, courtesy of the Federal Reserve Board. The impacts could reverberate through the home real estate and financing markets well into 2004.

In a staff study issued for comment just before Christmas, a Fed economist concluded that the two mortgage investors do little to lower home buyers' interest rates, but reap vast, multi-billion dollar benefits for themselves and their stockholders from government subsidies annually.

Though both companies insist that they lower interest rates significantly and make homeownership more affordable, Fed economist Wayne Passmore found that they actually lower rates by just 0.07 of a percentage point. That impact appears to be paltry in the face of the implicit federal subsidies to the corporations of between $119 billion and $164 billion a year. Passmore estimated that $97 billion of those subsidies are retained by the company shareholders.

"The GSEs' (Fannie's and Freddie's) implicit subsidy does not appear to have substantially increased homeownership or home building, because the estimated impact of (the two companies) is small," said Passmore.

The subsidies to Fannie and Freddie referred to by Passmore are "implicit" because they are indirect. Both firms -- congressionally chartered but privately owned and operated -- have lines of credit into the U.S. treasury that have never been drawn upon. Investors widely assume that, in the event of a financial crisis at either firm, the federal government would bail them out far beyond the amount of the credit lines. As a result, Fannie and Freddie's corporate debt offerings are considered nearly as safe as Treasury securities. They are classic examples of "too big to fail."

That gilt-edged perception of U.S. government backing allows both companies to borrow billions of dollars a year in the global capital markets at rates well below those of the largest and best-managed private banks and corporations. Passmore estimates Fannie and Freddie's borrowing-cost advantage at 40 basis points -- nearly half a percentage point lower than the cost of money to unsubsidized private competitors. In turn, he says, the ability to borrow at artificially low rates and the perceived federal backing has given both corporations enormous advantages on the stock market -- and now accounts for a stunning 42 to 81 percent of their entire market value.

Perhaps more important than the statistical conclusions in Passmore's study -- which Fannie and Freddie dispute -- is the study's timing and potential impact on an ongoing congressional debate. The Bush administration pushed for new legislation this fall designed to rein in Fannie and Freddie by giving the Treasury new oversight powers. The proposal is stalled on Capitol Hill at the moment, but the Fed staff study could add pressure to re-think the entire equation: What does the public get in direct, verifiable benefits from the billions in subsidies provided to Fannie and Freddie every year. Is it enough, given the riches the companies and their owners are piling up? And are corporations being responsibly managed?

Freddie Mac, in particular, has come under heavy criticism this past year for flagrant accounting standards violations. The company paid a $125 million fine for its errors and sacked its top leadership. Fannie Mae also admitted to accounting errors, but nowhere near the scale of Freddie's.

Both companies fear intrusive Treasury oversight and are rallying housing supporters in the real estate, home building and mortgage finance industries to defend it. Fannie Mae recently announced formation of a political fundraising political action committee (PAC), allowing it to contribute substantial sums to sympathetic congressional candidates and to help defeat its enemies.

Federal Reserve chairman Alan Greenspan has been critical of Fannie and Freddie's size, market dominance and massive potential bailout liability for taxpayers. But he did not comment upon or endorse the Passmore study.

But financial analyst Bert Ely said that "anyone familiar with the vetting process within the Fed knows full well that Board staff and the Board of Governors, and specifically the Chairman, are quite comfortable with the study, its numbers, and its conclusions."

Greenspan's views -- if stated publicly and forcefully -- could move mountains on Capitol Hill in 2004.

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