/ Business

10:57 AM EDT on Wednesday, April 6, 2005

By JEANNINE AVERSA / AP Economics Writer

WASHINGTON, D.C. — Federal Reserve Chairman Alan Greenspan urged Congress Wednesday to limit the size of the multibillion-dollar portfolios held by mortgage giants Fannie Mae and Freddie Mac, warning that simply creating a strong regulator would not suffice.

"World class regulation, by itself, may not be sufficient," Greenspan said in prepared remarks to the Senate Banking Committee.

Fannie Mae is the No. 1 U.S. buyer of home mortgages, while rival, Freddie Mac, ranks as second-largest buyer.

A debate over the appropriate regulation of the two mortgage titans has taken on heightened scrutiny in the wake of accounting scandals at both Fannie Mae and Freddie Mac.

"Without restrictions on the size of (their) balance sheets, we put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for homeownership," Greenspan said.

Prospects for passage of legislation appear stronger than in previous years, when the two politically influential companies successfully lobbied against new restraints. The Bush administration wants to see legislation enacted, though it has not endorsed a specific plan.

Congress created Fannie Mae and Freddie Mac to inject money into the home-loan market. They buy mortgages and bundle them into securities for sale to investors worldwide.

The director of the Office of Federal Housing Enterprise Oversight, which has been investigating Fannie Mae's accounting since last year, was testifying Wednesday before a House subcommittee on the company's new agreement with the agency to set up policies to prevent faulty bookkeeping and make governance changes.

Armando Falcon, a Democrat appointed by President Clinton, told President Bush in a letter Tuesday that he will step down on May 20. He submitted his resignation two years ago but stayed on to deal with problems at the companies.

Rep. Richard Baker, R-La., chairman of the House subcommittee that oversees Fannie Mae and Freddie Mac, proposed legislation that would strengthen the government's hand over them.

"The terrible troubles at Fannie Mae make it painfully clear that major reforms are necessary to strengthen regulatory oversight" of the two companies "to reduce the risks to taxpayers and investors, and to improve our commitment to serving America's homebuyers," Baker said at a news conference Tuesday.

Greenspan's remarks about the two mortgage giants repeated a warning that the Fed chief has been issuing for more than a year: that the country's financial system could be put at risk unless the growth of the two giant mortgage lenders is restrained.

Limiting the size of Fannie's and Freddie's portfolios won't affect mortgage rates for homeowners, Greenspan said, citing a study by the Federal Reserve.

At the end of 1990, Fannie's and Freddie's combined portfolios amounted to $132 billion, or 5.6 percent of the single-family home mortgage market, Greenspan said. By 2003, those combined portfolios had grown tenfold, to $1.38 trillion or 23 percent of the single-family home-mortgage market, he said.

Greenspan said Congress should either set a limit on the two mortgage companies' portfolio holdings or lay out guidelines for regulators to use.

When the two companies were small, the potential for risk to the financial system and the overall economy was pretty small, Greenspan said. "Regrettably, that is no longer the case," he added.

Because the institutions have grown so large, the risk is that a failure of one or them would probably put the federal government in the position of having to bail out investors.

Currently, the two institutions are hedging their risk and are financially okay, Greenspan said. He urged Congress to act now - in the absence of a crisis. If the companies were to hit a problem hedging risks, "we know with a high degree of probability that something adverse will go wrong," he said.

Prospects for passage of a bill to tighten regulation on Fannie Mae and Freddie Mac appear stronger now after failed attempts in the past. "It is of upmost importance to enact legislation this year," said Elizabeth Dole, R-N.C., who helped write a bill tightening controls over the two mortgage companies.

Federal regulators last year accused Fannie Mae of serious accounting problems. It was ordered to restate earnings back to 2001, a correction that could reach an estimated $11 billion. The accounting fiasco led to the ouster of the company's chief executive and top financial officer.

Freddie Mac had its own accounting debacle in 2003, where three top executives were forced out. It had misstated earnings by $5 billion for 2000-2002.