Fed Chief Urges Cutback in Scale of 2 Big Lenders

By EDMUND L. ANDREWS
NYTimes.com

WASHINGTON, Feb. 17 - The Federal Reserve chairman, Alan Greenspan, urged Congress on Thursday to sharply scale back Fannie Mae and Freddie Mac, the giant and troubled government-sponsored mortgage companies.

His comments were the first on the matter since Fannie Mae acknowledged major violations of accounting rules and forced out its chief executive in December. Mr. Greenspan said that the two companies had grown so big that they posed a "substantial risk" to the economy.

Under pressure from banking regulators and the Securities and Exchange Commission, Fannie Mae is being forced to restate its financial results for the last three and a half years and may have to reduce its earnings by $9 billion. Freddie Mac went through similar trouble in 2003, when it acknowledged that it had used accounting gimmicks to smooth out its earnings between strong and weak years.

Mr. Greenspan, who has long criticized both companies, said they had been able to borrow almost unlimited amounts of money at below-market rates by virtue of the widespread but false impression among investors that the federal government would ride to their rescue if necessary.

"Given no limits on what they can put in their portfolios," he told members of the House Financial Services Committee, "they can, by merely their initiative, create an ever larger increase in portfolio, which, given the low levels of capital, means they have to engage in very significant dynamic hedging to hedge interest rate risks."

"We have found no reasonable basis for that portfolio above very minimum needs," Mr. Greenspan continued, proposing that the two companies reduce their portfolios of mortgage loans to about $100 billion or $200 billion from a combined total of $1.7 trillion today.

A spokeswoman for Fannie Mae had no comment on Mr. Greenspan's testimony.

In the past, the two big financiers have argued that they provide a significant savings to home buyers through their programs and that holding mortgage portfolios has always been part of their business.

Mr. Greenspan's comments came as Congress and the Bush administration attempt sweeping changes in how Fannie Mae and Freddie Mac are regulated.

Both companies were created by Congress to reduce the cost of home loans, and do so primarily by buying up mortgages and bundling them into securities that are then sold in the financial markets.

Mr. Greenspan emphasized that the companies did a good job of securitizing home mortgages, but he said they were taking on too much risk by letting their own portfolios of loans balloon in the last decade.

"If you get large enough in that type of context and something goes wrong, then we have a very serious problem," he said in response to a question from Representative Richard H. Baker, Republican of Louisiana. "At this stage, the risk is, as best I can judge, virtually negligible. I don't believe that will be the case if we continue to expand."

Mr. Baker, who is among those preparing legislation to regulate "government-sponsored enterprises" like Fannie Mae and Freddie Mac, made clear that he wanted to slow the companies' borrowing and expansion. "I have come to the conclusion, in view of the G.S.E.'s portfolio growth over the last several years, that the rate of growth is indeed a concern," he said.

Many Bush administration officials agree, with some characterizing Fannie Mae as less a mortgage company than an enormous hedge fund.

But the two companies have powerful political support and have been able to fend off restrictions for years. Supporters include the real estate brokerage industry as well as home builders and many mortgage lenders around the country. The companies, based in Washington, have cultivated ties to lawmakers and continue to enjoy support from many Democrats.

Mr. Greenspan has taken a dim view of Fannie Mae and Freddie Mac, which enjoy privileges that include a special credit line with the Treasury Department.

The Federal Reserve angered the two companies with a study last year concluding that their shareholders, not home buyers, received most of the economic benefit from their ability to borrow money at below-market rates.