Federal Reserve Chairman Alan Greenspan today urged the US Congress to curb the rapid growth of Fannie Mae and Freddie Mac, saying this was vital to cut the risks the mortgage finance giants pose to the US financial system.
In tough testimony prepared for delivery to the Senate Banking Committee that comes as Congress considers stronger regulation for the government-sponsored enterprises (GSEs), Mr Greenspan said rules without growth restraints could actually worsen the dangers the companies pose.
"World-class regulation, by itself, may not be sufficient and, indeed, might even worsen the potential for systemic risk if market participants inferred from such regulation that the government would be more likely to back GSE debt in the event of financial stress," Mr Greenspan said.
"This is the heart of a dilemma in designing regulation for GSEs." But he proposed a solution. "We at the Federal Reserve believe this dilemma would be resolved by placing limits on the GSEs' portfolios of assets, perhaps as a share of single-family home mortgages outstanding or some other variation of such a ratio," the Fed chief said.
Together, the portfolios of both companies amount to some $1.5 trillion.
Mr Greenspan previously has proposed that those portfolios be cut to $200 billion for each company.
The influential Fed leader said that while Fannie Mae and Freddie Mac have not expanded their portfolios significantly during the past year, this restraint could not be counted upon once the companies sort out recent accounting problems.
"It is a reasonable presumption that rapid growth is likely to resume once Fannie and Freddie believe they have resolved their current difficulties," Mr Greenspan said, adding that this meant legislative restraints were necessary.
"To fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later," he said.
Mr Greenspan said strengthened regulation might boost the market's view that GSEs are extensions of government. However, he said, "If we fail to strengthen GSE regulation, we increase the possibility of insolvency and crisis." Accounting woes that surfaced at Freddie Mac in 2003 led to a $5 billion earnings restatement.
Fannie Mae's problems are still coming to light. Based on what is known so far, these could lead to a profit restatement of as much as $11 billion.