Sometimes doing nothing has its own rewards.

At the end of 2005, the Office of Federal Housing Enterprise Oversight (OFHEO) announced that Fannie Mae and Freddie Mac, the two government sponsored enterprises (GSEs) responsible for maintaining a national mortgage market, exceeded their capital requirements -- Fannie at $37 billion by $752 million; Freddie, at $36.3 billion, by a whopping $4.7 billion.

The finding is significant because the two mortgage giants’ capital requirements were increased by 30% after accounting errors were disclosed in 2003, errors that led to the forced resignation of their top executives and required a restatement of earnings, about $11 billion downward for Fannie and $5 billion upward for Freddie.

And these gains in financial safety were made without Congress enacting the Draconian reforms critics in the White House, Federal Reserve, Congress and some think tanks were demanding last year.

The accounting irregularities bolstered critics’ claims that a portion of the GSEs business -- their buying of mortgages financed through the issuing of bonds -- might pose a systemic risk to the financial system if left unchecked.

Some, including Fed Chairman Alan Greenspan, called for reducing the two GSEs’ portfolios from $1.5 trillion to about $200 billion. That minimum amount would be required for them to carry out the other part of their mortgage market making purpose, the buying and bundling of mortgages together to sell directly to investors, for which they receive a fee.

The portfolio reform really never made much sense, except for those who wanted to push for full privatization of the GSEs or to certain national banks that would gain an advantage over regional competitors by limitations on GSE mortgage activities.

But at what cost? Homebuyers here have one product available to them home buyers elsewhere don’t -- the 30-year, fixed-rate, prepayble mortgage. That is one major reason homeowning is so affordable here, and why homeownership rates here are the envy of the rest of the world. Making that possible has been the GSEs making a national mortgage market available, both through their securitization of mortgages and, during times of liquidity crunch, the buying of mortgages for their own portfolios.

The most curious thing about the reform effort, though, is that the accounting irregularities had nothing to do with the mortgage portfolios, which the critics targeted.

This truth about the GSEs and their critics was laid bare in a speech to the Bond Market Association in Hong Kong by Stephen A. Blumenthal, acting director of the OFHEO, which oversees the two GSEs.

The speech is remarkable in two senses. Blumenthal was responsible for helping uncover problems at Freddie Mac, so he is intimately aware of its problems. More importantly, by rubbing against the White House and Treasury positions on the GSEs, Blumenthal assured himself that he would not be made permanent director of OFHEO or any subsequent agency.

Thus what he had to say was both knowledgeable and without self-interest. And what he said was this:

Freddie’s and Fannie’s financial problems had nothing to do with faulty risk management of their mortgage portfolios, as some critics had intimated, but accounting and management impropriety.
Fannie and Freddie portfolios aren’t without risk, but “their credit risk management has been exceptional and their actual experience with interest rate risk should satisfy even the most critical.”
Concerns about the risks Fannie and Freddie pose to the economy “are concerns about ‘potential’ impacts and not based on actual experience.”

That last point makes great sense when you look at the actual figures. The GSEs’ portfolios account for only 18% of the mortgage market. Banks hold 46% of the $9.2 billion in residential mortgages outstanding, with life insurance companies, foreign investors, pension funds and individuals holding the rest.

Thus, if you are talking about systemic risk from mortgage portfolios, for all that Congress may do to increase regulatory authority over the two GSEs, managing the risk will require a “collective effort of GSE and financial service regulators as well as other participants in the financial system.”

The notion that the risk would go away if only the GSEs get rid of their portfolios is laughable. It only spreads the risk around more, from those with exceptional skills in managing it to, perhaps, those with less adequate skills. And as University of Florida finance scholar Mark Flannery, co-author of Flannery & Flood’s ProBanker financial game and editor of Money, Credit and Banking, noted in a mid-year presentation at the American Enterprise Institute, that makes as much sense as giving everybody a bit of nuclear waste to keep in their basement rather than concentrating it in a place and in the hands of people who could deal with it safely.

Only in this case, both homeowners and investors would suffer the fall out.

“You reduce the profitability of these companies (as reducing their portfolios would do) and you’ve just caused a massive sell-off of the equity in these companies,” Blumenthal noted in response to a question after his speech. “That would really be sort of a trick played on shareholders. ... That is a fact and considering the massive holdings of Fannie Mae and Freddie Mac stock by mutual funds and pension funds, it is something the policymakers should take into consideration in crafting legislation.”

As for homeowners, if investors decide not to put as much money into mortgages, what good will come for them from that? Higher interest rates and more difficulty selling homes, perhaps?

So, the good news of the last year is that the Congress did nothing and the GSEs appear to have put their financial house in order. More good news this year is that while the White House and others are still talking about GSE reform, they are talking about improving oversight and not pointing at their portfolios.

The less Congress and the administration do, the better off homebuyers will be.

ABOUT THE AUTHOR

Duane Freese has 26 years experience writing opinion, features and news. He is known for reducing complex subjects such as telecommunications deregulation and federal budget deficits into understandable terms that keep people attentive. Mr. Freese began his career at the Battle Creek Enquirer, where he rose from a general assignment reporter to editorial page editor in five years. As editorial page editor, he won first place awards from Gannett and from the Associated Press of Michigan for his editorials. He led campaigns to create a commission on police brutality against minorities and on behalf of community services for the mentally retarded and mentally restored. In addition to writing daily editorials, Mr. Freese also wrote weekly columns to add a face and a name to the editorial page of the newspaper, making it less impersonal. For his editorial work, he was recognized as one of only 15 journalists from around the globe awarded fellowships to the University of Michigan in 1986. After his yearlong fellowship, Mr. Freese was invited to join the USA TODAY editorial board where he became an editor-writer. In his nearly 13 years at USA TODAY, he argued for and won board consensus on issues such as balanced budgets, tort reform and economic deregulation. He also helped explain investment and retirement issues, drawing on knowledge gleaned as the author of "Retirement Planning: The Real Mid-Life Crisis." And he played a key role in the first major redesign of USA TODAY's editorial pages in 1991 as the back-up director of editorial page operations. During the O.J. Simpson murder trial, Mr. Freese wrote editorials on legal issues from cameras in the court to the admissibility of DNA evidence. He wrote numerous editorials dealing with Federal Reserve policy and trade related issues arising from the Asian economic crisis of 1997 and 1998. In the Monica Lewinsky case, he researched and wrote editorials dealing with Ken Starr's investigative techniques and President Clinton's privilege claims. And in 1998 and 1999, his editorials focused on the New Economy being created by computers and the telecommunications revolution. His writing won him numerous in-house awards, including being named to the first group of USA TODAY fellows for 1997 and 1998. Born and reared in the Detroit area, Mr. Freese graduated from Albion College with a Bachelor of Arts degree in 1971. He attended the University of Michigan Graduate School of Business Administration, studying international economics and business and government before doing graduate work in journalism at the University of Missouri-Columbia, where he also took part in the London reporting program. Mr. Freese currently is living in Falls Church, Virginia, where he is engaged in personal writing projects. Duane Freese is TCS Senior Writer.