Government Sponsored Enterprises (GSEs)

Fannie Mae and Freddie Mac which dominate the nation’s housing finance market get most of the attention when the subject of Government Sponsored Enterprises (GSEs) comes up in Washington.

But, Fannie and Freddie are not alone in this growing world of government sponsored enterprises which operate in a twilight zone somewhere between government and free enterprise. Financing for housing, students, financial institutions and agricultural operations are among the functions that are being carried out through the government sponsored structure.
While the subsidy flowing from their links to the federal government vary, all the GSEs enjoy the implicit guarantee that the federal government would not allow the enterprises to default on their obligations. This means that the GSEs are able to reduce their debt costs substantially below that of similar corporations which operate without government sponsorship. In fact, most of the GSE borrowing is at rates only a small fraction above that enjoyed by the federal government, itself.

“The perception of government backing permits the GSEs to operate with much higher leverage than other companies: investors in GSE obligations look to the government’s guarantee rather than to the financial strength of the GSE as the basis for repayment,” says Washington attorney Tom Stanton in his new book, “Government-Sponsored EnterprisesàMercantilist Companies in the Modern World.”

Stanton, who has spent a lifetime studying the GSEs, describes the government as a “silent equity partner” of GSE shareholders by providing financial backing equivalent to tens of billions of dollars of equity–for which the government requires no financial return.

The big question for all the GSEs is whether a legitimate public purpose is being met through the use of this government benefit or whether the implicit subsidy is simply enriching the private shareholders and the executives of the GSEs.

The newest of the GSEs is the Federal Agriculture Mortgage Corporation which has been dubbed Farmer Mac. Farmer Mac was created under the Reagan Administration in 1988 as a vehicle to provide credit for farms and rural housing. In the mid 1990s, I raised questions about just how well this mission was being carried out.

In 1997, the General Accounting Office (GAO) confirmed that more than half of Farmer Mac’s on-balance sheet asset holdings were in investments other than agricultural mortgages. So, the status as a government sponsored enterprise was being used to invest in non-agricultural paper to generate arbitrage profits for the corporation and its shareholders.

That year, Farmer Mac directors began awarding themselves stock options. The 15 board members have average stock holdings valued at $816,249, according to a compilation by the New York Times. Nine of the directors made millions more selling shares, the report said.Last year, Henry Edelman, Farmer Mac’s chief executive, received salary and stock options of $1.8 million. Edelman, according to news reports, controls $27.6 million of Farmer Mac stock.

More recently the Times has reported that Farmer Mac has generated income in the form of fees for guaranteeing loans already sitting on the books of banks. This seems far afield from Farmer Mac’s mission to generate new credit sources in rural America.

In addition, the Times reports dissension between the board of directors and the management of Farmer Mac. One of the recently resigned directors charged that Farmer Mac was “taking outsized risks.”

Farmer Mac was defensive in its response to the news article, charging that the story had been prompted by “short sellers” of the GSE’s stock.

The new flap over Farmer Mac once again points to the weak oversight by the Congress and the Administration over the entire range of GSEs. All the GSEs pose potential risks for the taxpayers. The market presumes correctly that the federal government will never allow any of the GSEs to fail. That means the taxpayers are the last line of defense. In the case of Fannie Mae and Freddie Mac there is no question about the taxpayer liability. Each of these housing GSEs has a $2.25 billion automatic draw from the U. S. Treasury in the event they fall on hard times.

While Farmer Mac is subject to registration under the Securities and Exchange Act, the giants–Fannie and Freddie–are exempt. In the wake the Enron debacle, Representatives Ed Markey and Chris Shays have introduced legislation that would end the exemption and require Fannie and Freddie to register their securities. So far, it has generated little support from Congressional leaders of either party.

The apathy of Congress and the Executive Branch is appalling in the wake of the size and the rapid growth of the GSEs. Here’s the list: Farm Credit System, $94 billion in assets; Federal Home Loan Bank System, $654 billion; Fannie Mae, $607 billion in assets plus $707 billion of mortgage-backed securities guaranteed; Freddie Mac, $386 billion assets plus $576 billion of mortgage backed securities guaranteed; Sallie Mae (student loans) $48.8 billion assets; Farmer Mac, $3.2 billion assets plus $1.5 billion of mortgaged backed securities guaranteed.

The Bush Administration and the Congress need to put a high priority on a top to bottom examination of all the GSEs to determine: (1) how well their statutory mission is being carried out; and (2) the safety and soundness and the adequacy of protections for the taxpayers against bailouts.