Paulson: GSE Action Critical

WASHINGTON - Treasury Secretary Henry Paulson yesterday strongly urged Congress to act quickly to pass legislation that would create a new regulator and enable the Treasury to be a financial backstop for Fannie Mae and Freddie Mac, warning that such action is critical to restoring public confidence in the two secondary mortgage market giants.

Without such changes, the companies pose risks to the health of financial markets both here and abroad.

He made the plea at a Senate Banking Committee hearing on proposals he unveiled Sunday that would allow the Treasury to provide liquidity to the two government-sponsored entities or to purchase equity in them over the next 18 months, if necessary, to prevent them from failing and jeopardizing the economy and financial markets

But several members of the Banking Committee balked at Paulson's proposals, worrying that Treasury is essentially asking Congress to give it "a blank check" to bail out the two companies without any assurances that this is in the best interest of taxpayers.

Committee chairman Christopher Dodd, D-Conn., told Paulson that he recognizes "there is much at stake" and agrees that "inaction is not an option." Nevertheless, he said that he and other committee members "want to make sure that we've thought about this very carefully."

"We're not going to do something we're going to regret," he said, telling Paulson he will have to provide more details of some aspects of the proposals. Dodd told Securities and Exchange Committee chairman Christopher Cox that he wants SEC officials to review the Treasury proposals. Cox urged Congress to take away Fannie Mae and Freddie Mac's exemption under the Securities Act of 1933 so that they are forced to periodically report on their finances like other corporations.

After the hearing, Dodd told reporters that he will try to add some version of the Treasury proposals to housing legislation that the Senate passed Friday, but said: "We want to examine them closely before they are added to this housing bill."

Meanwhile, Sen. Robert Casey, D-Pa., tried to use the Treasury proposals as leverage to get the Bush administration to rescind its veto threat against the housing legislation passed by the Senate. Bush threatened to veto the measure partly because it would provide Community Development Block Grant funds to state and local governments to purchase foreclosed properties.

"You tell the president that if this is to be enacted, he's got to help us on this," Casey said. "He can't just be a partisan fighter."

Paulson claimed it is critical for Congress to pass legislation that would bolster Fannie Mae and Freddie Mac.

"People all around the world are watching us," he said. "This should be done quickly. [It] would be a great confidence builder throughout the world," Paulson said. He noted that the GSEs are critical to the availability of housing in the U.S., that their stock and debt are held by investors all over the world, and that their instability would pose systemic risk to the economy and financial markets.

"The GSEs now touch 70% of new mortgages and represent the only functioning secondary mortgage market," he warned.

Up until two years ago, the two GSEs were huge buyers of municipal housing bonds. They still buy some muni bonds and provide some credit enhancement in the muni housing market.

Paulson tried to provide banking committee members with Treasury's rationale for the proposals. He said he asked that Congress give Treasury the new authority for 18 months because it is unclear how long the housing market will be in turmoil, it will take time to create a new regulator for Fannie Mae and Freddie Mac, and the new administration to be elected in November will need time to get up to speed on the two GSEs.

Paulson insisted there are no plans for Treasury to bail out the two GSEs and said he hopes that they never need Treasury's help. "This is a back-up facility that hopefully will never be used," he said.

Paulson said he deliberately did not specify the amount of help that Treasury might give the GSE's or set limits on those amounts to avoid exacerbating the situation surrounding them.

"If you've got a squirt gun in your pocket and people know that, you may have to take it out and use it," he said. "But if you've got a bazooka, you may not have to take it out."

Paulson said the proposed 18 months of authority for the Treasury to provide liquidity and possibly purchase equity in Fannie and Freddie would be short-term and temporary. A third Treasury proposal, that would be permanent, calls for Congress to provide the Federal Reserve System with the authority to access information and for the Fed to consult with the new GSE regulator on setting capital requirements and other prudent standards.

Dodd asked Paulson why not just let the GSEs borrow from the Fed's discount window at below market rates.

Paulson said that Congress in 1971 authorized the Treasury to provide a line of backup credit of $2.25 billion to each of the two GSE's at a time when their assets were a small percentage of what they are now and that it seemed logical to build on and modernize that authority.

"We think this is the best way to limit the cost to the taxpayer," he said.

Fed chairman Ben Bernanke, who also spoke at the hearing, told the lawmakers it is most appropriate for the Treasury to set the criteria for providing financial assistance to the two GSEs.

The committee's ranking minority member, Sen. Richard Shelby, R-Ala., tried to get Paulson to say what circumstances would trigger the Treasury's decision to provide help to the GSEs - if its equity price falls below $1.00 or if it can't issue debt?

But Paulson declined to be specific, saying: "It would be self-defeating to start putting limitations on that."

Committee members were clearly nervous about giving the Treasury unlimited authority.

"It's counterintuitive to say we have to give you a blank check to protect taxpayers," said Sen. Robert Menendez, D-N.J.

"You're talking about potentially spending $1 trillion here," said the committee's newest Democrat, Sen. Jon Tester, of Montana. Tester insisted the Treasury secretary respond in writing to his question about what the cost would be if Congress chooses to do nothing.

"If I'm going to give you authority to spend an unlimited amount of money, I want to know what happens if we do nothing," he said.

The harshest critic of Treasury proposals was Sen. Jim Bunning, R-Ky., who called them "socialism here in the United States of America" at a banking committee hearing on monetary policy earlier in the day.

He told Paulson at the hearing on the Treasury proposals that "your plan is not being accepted" by investors because Fannie and Freddie stock had dropped 26% and 29%, respectively, as of about 1:30 p.m. yesterday. Fannie Mae closed yesterday at $7.07, down $2.66 or 27.34%, while Freddie Mac closed at $5.26, down $1.85 or 26.02%.

But Sen. Charles Schumer, D-N.Y., noted that Freddie Mac's debt offering Monday was oversubscribed, a sign of investor confidence in the giant GSE. Schumer made clear he supports Paulson's proposals.

"I for one think you have put together a good plan," he said. "You need broad solutions. The irony is, the more limits we put on this, the more antsy the markets will be. I hope we can move this quickly."

Both Dodd and Shelby worried Paulson might be trying to do an end-run and use the housing crisis as a back door to getting Congress to agree to increase the role of the Fed in financial regulation.

Paulson tried to assure them this is not the case. "It's going to be a long time before the regulatory structure is changed so it meets up with the world we live in," he said.

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