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Sub-prime trust

Accounting scandals at Fannie Mae and Freddie Mac are still too fresh to permit an increase in investor limits.

August 11, 2007

President Bush has come under fire -- deservedly -- for dismissing instability in mortgage markets as little more than a hiccup in an otherwise "thriving" economy. The credit turmoil was so pronounced this week that central bankers in the United States and Europe poured billions of dollars into their financial markets to ease the crunch. But Bush was right on Thursday when he rejected calls to lift investment limits on Fannie Mae and Freddie Mac.

Fannie and Freddie are government-sponsored entities, independent companies originally chartered by Congress to pump money into the housing market and make mortgages more affordable. Today, they finance or guarantee nearly 75% of American home mortgages, issuing loans or buying loans issued by other lenders and reselling them as bonds. Although these bonds aren't guaranteed by the federal government, many investors regard them as if they were, and it is widely assumed that if Fannie and Freddie were to fail, the government would bail them out.

Both companies hold large loan portfolios, worth more than $700 billion each. The Office of Federal Housing Enterprise Oversight, which oversees Fannie and Freddie, limited growth of these investment pools after accounting scandals at both companies.

Proponents of lifting the limit believe letting Fannie and Freddie own more loans again will stabilize the housing market. It might help increase the supply of money for housing loans, counteracting investors' wariness of mortgage-backed securities, but it's no solution to the sub-prime mess. The companies don't buy the high-risk loans that have put so many borrowers into foreclosure. And they shouldn't: The government (or, in this case, its affiliates) doesn't belong in the business of creating a market for ill-advised financial schemes. More important, as Bush noted, the companies still aren't out of the accounting-fraud woods. Fannie Mae has yet to report earnings for this year or last.

Lifting the investment limit is not the only way the companies can pump funds into the market. They can still package loans and sell them as bonds. The market might be skittish now, but mortgages with reasonable terms should attract investors before long.

As publicly traded companies, Fannie and Freddie may want to expand their holdings at a time when mortgage debt is cheap. But with taxpayers potentially on the hook if they fail, they haven't earned that opportunity.

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