CHAPTER 13

A Compromise Attempt Turns into Full-Scale War

FANNIE MAE’S RELATIONSHIP WITH OFHEO, WHICH HAD BEEN difficult since Armando Falcon became director in the fall of 1999, worsened noticeably after Falcon hired Steve Blumenthal as counsel to the director in July 2002. Blumenthal came to OFHEO from Schwab Washington Research Group, where he followed Fannie Mae and Freddie Mac as an analyst specializing in financial services. Prior to moving to Schwab, Blumenthal had served as counsel to the House Energy and Commerce Committee and then been vice president and director of regulatory relations for the Securities Industry Association (SIA, now SIFMA), a trade group representing securities firms, banks, and asset managers.

Tensions with OFHEO Escalate

My first experience with Blumenthal came soon after he joined OFHEO. In September 2002, I had been called to OFHEO to brief Falcon on how Fannie Mae planned to reduce the 14-month August duration gap we were about to report publicly.. Blumenthal was at that session. Shortly afterwards I flew out West for a series of investor meetings. In one of them, a senior portfolio manager at a mutual fund told me he had received a phone call from “an assistant to Mr. Falcon” (subsequently confirmed to have been Blumenthal), informing him that Falcon had directed us to bring the duration gap to 12 months or less by the end of September or face regulatory consequences. That was not true, and even if it had been, it was highly improper for an OFHEO official to make a selective disclosure of nonpublic information about a company his agency regulated.

We learned of other instances in which Blumenthal made what we believed were inappropriate disclosures of regulatory information, and in January 2003, Fannie Mae General Counsel Ann Kappler sent a letter to OFHEO General Counsel Pollard citing several of these instances and asking OFHEO to put a stop to the disclosures. Kappler told Pollard that she was making this request out of a fiduciary duty to Fannie Mae’s shareholders and in spite of the danger of regulatory reprisal. The response to Kappler’s letter came not from Pollard but from Falcon. Falcon denied that any of the information Blumenthal had disclosed was nonpublic. He also said that OFHEO had begun a program of outreach to Fannie Mae and Freddie Mac’s institutional investors at his direction, for what he claimed were safety and soundness reasons, and that the outreach would continue.

We were battling OFHEO over another issue at around the same time. Since 2001 Falcon had been saying that his economists and researchers were working on a report about Fannie Mae and Freddie Mac’s systemic risk. This was one more example of the profound difference in the way Fannie Mae and banks were regulated. Just as no bank regulator would have had their senior officials call the investors or security analysts of any of the companies they regulated, neither would the Federal Reserve or Treasury ever have considered putting out a report titled “Large Commercial Banks and Systemic Risk.” We thought the Fannie Mae systemic risk study was a very bad idea, and we said so to Falcon.

Throughout 2001 and 2002, FM Watch and its allies had been conducting a relentless campaign to convince the public that Fannie Mae posed unacceptable risk to the financial system. We knew that was not the case, but we were virtually alone in saying so. I often thought how valuable it would have been to have a safety and soundness regulator with the objectivity and expertise to examine our risk management practices and the credibility to vouch for them (or critique them) publicly. In OFHEO we had just the opposite. During my time at Fannie Mae, no senior OFHEO official—outside of the examination staff—expressed any interest in learning about how we viewed and managed our financial risks. From what we had been able to gather, the proposed OFHEO systemic risk study was not going to be about our risks and how we managed them. Instead it would be an exercise focused on the role of OFHEO in mitigating the systemic effects triggered by a hypothetical failure of either Fannie Mae or Freddie Mac. Far from helping to counteract the FM Watch propaganda, the OFHEO systemic risk study would reinforce and build on it.

Early in 2003, it was apparent that Falcon was going to publish his study in spite of our opposition, so we went to Treasury and the White House and asked them to intervene to stop it. Falcon picked February 4 as the day for the systemic risk study to be released. He arranged for copies to be sent to key politicians and scheduled a speech before the Bond Market Association in New York to publicize it. Before he could give that speech, however, he received a call from the White House personnel office requesting his resignation so that President Bush could appoint his own director, a man named Mark Brickell, to run OFHEO. Falcon resigned that day, although he said he would remain in office until the Senate confirmed his successor. Stories the following day in the major newspapers covered the Brickell appointment but made little mention of the systemic risk study.

The timing of the White House call convinced Falcon that Fannie Mae had arranged it in retaliation for his having gone ahead with the study. That gave us too much credit. The White House had given us a heads-up before the announcement, but we were not consulted in advance. Falcon was a Democrat, a protégé of Henry Gonzalez, and a Clinton appointee. The White House had been looking for a replacement for him and finally had found one in Brickell. Brickell was CEO of a derivatives trading company called Blackbird Holdings, who had spent 25 years with JP Morgan and was one of the country’s leading experts in derivatives. He founded the International Swaps and Derivatives Association—the trade group for participants in the over-the-counter (OTC) derivatives market—and while at JP Morgan had spent countless hours in Washington lobbying members and their staffs on OTC derivatives-related issues. The administration believed that Brickell’s combination of derivatives knowledge and Washington experience made him an ideal candidate to head OFHEO.

But Brickell could not get confirmed, ironically because of questions raised by Senate Democrats, led by Sarbanes. At a hearing in July, Sarbanes cited Brickell’s lobbying against the regulation of derivatives and his support for Fannie Mae’s proposed “supervisory” approach to OFHEO’s risk-based capital standard while at JP Morgan as reasons for concern that he might not be tough enough on us. Those reservations could not be overcome, and almost a year after Brickell’s nomination, in January 2004, the White House withdrew it. Falcon remained at OFHEO, believing Fannie Mae had tried but failed to have him removed. Had there been any doubt before, from that point on he was a committed enemy.

Ten Years of Peace

The political landscape shifted again in 2003. After the 2002 midterm elections, Republicans regained control of the Senate, and Alabama Senator Richard Shelby replaced Sarbanes as chairman of the Senate Banking Committee. Treasury Secretary O’Neill was forced to resign by President Bush in December 2002 and was replaced by John Snow. Like O’Neill, Snow had a mix of government and private industry experience. He held a PhD in economics and a JD in law. After a short stint as a practicing attorney, Snow took a series of jobs in the Department of Transportation under President Ford in the 1970s, ultimately being named administrator of the National Highway Safety Commission in 1976. His experience in the Ford administration led him to a career in the railroad industry, where he rose to become chairman of a railroad conglomerate called CSX in 1991. He held that position until sworn in as Treasury secretary in February 2003.

As he had done with O’Neill, Raines went to see Snow very shortly after he assumed office. The two men knew each other from the Business Roundtable—a group of business CEOs who sought to have an impact on public policy issues—and they were able to draw on that familiarity to establish an open and candid dialogue. Raines quickly found that unlike Larry Summers, Snow did not have predetermined views on the issues that gave rise to the conflict between the GSEs and our competitors and critics, and more so than Paul O’Neill, Snow felt he might be able to play a useful role in helping to resolve those issues. Snow’s willingness to engage on what Treasury called “the GSE problem,” together with his lack of any personal or ideological agenda on its key components, suggested to Raines a possible way of addressing the intense political opposition to Fannie Mae that had been building since the beginning of his chairmanship.

We had no major conflicts with the Bush administration; to the contrary, as recently as October 2002, the president had praised Raines and Fannie Mae publicly. Snow, not Summers, was Treasury secretary. And Baker seemed to have moderated his demands. He held only two hearings on the government-sponsored enterprises in 2002, and his April 2003 inquiries to Treasury and HUD indicated that the focus of his GSE concerns had narrowed to regulation and governance. Both were issues in which we had an interest as well. We had reached the end of our rope with OFHEO and were eager to consider alternatives. We believed that a strong, capable, and credible regulator would be better for our investors, as long as that regulator was objective and not politicized. And ambiguities in our charter and governance lay at the heart of our battles with large lenders. Clarifications in some of these areas, including selected concessions on our part, had the potential to lower the competitive temperature to everyone’s benefit.

Weighing these factors, Raines made a crucial decision. Eleven years had passed since the landmark GSE legislation in 1992, and during that time many of the issues thought settled then had been put back into play. There now seemed to be an opportunity to achieve, as Raines put it, another “10 years of peace” politically for Fannie Mae. He did not want to let that opportunity slip by. Having resisted efforts at GSE legislation since the beginning of his chairmanship, Raines would change tack and work with Snow and Treasury to produce a bill Congress could pass.

Baker introduced HR 2575 on June 24, 2003. His bill abolished OFHEO and shifted safety and soundness regulation of Fannie Mae and Freddie Mac to the Office of Thrift Supervision (OTS), under Treasury. The bill contained a number of new GSE regulatory powers for the OTS, but it did not revoke Treasury’s $2.25 billion GSE backstop as his 2000 legislation had done. Baker said he had discussed his legislation informally with Treasury but had no understanding with Snow about any of its provisions, and that he had introduced his bill merely “to stake out a proposal.” House Financial Services Committee Chairman Mike Oxley said he would hold hearings on the Baker bill in September, when representatives of the government-sponsored enterprises and the administration would be invited to present their views on it.

Raines and Snow spent the summer in discussions over the content of a bill both could support. They agreed that OFHEO should be replaced with a new safety and soundness regulator, housed within the Treasury Department. They also agreed on removing the budget of the new regulator from the appropriations process and on giving HUD enhanced powers for enforcing the GSEs’ affordable housing goals. Raines made a major concession on risk-based capital, in which he was willing to allow flexibilities in the standard that we had been unwilling to concede in 1992. (OFHEO’s failures in implementing the 1992 version made this concession easier.) But he took firm stances against allowing the new safety and soundness regulator to change our minimum capital requirement and against moving program approval authority from HUD to the new regulator.

By the time of the Oxley hearings, Raines and Snow had reached agreement on all of the principal provisions of the proposed legislation, and they had a handshake deal on what each would say in their respective testimonies. Following established procedure, Snow submitted his written testimony to the National Economic Council (NEC)—the economic policy coordination office of the White House—for review by the Bush administration’s economic policy team. At that point, things began to go badly awry.

The Administration Rises in Opposition

When Snow appeared before Oxley’s committee on September 10, he said in both his written and oral testimonies that Treasury supported the proposed new safety and soundness regulator being given the authority to oversee existing as well as new government-sponsored enterprise activities to ensure they were consistent with our charters. That was contrary to what had been agreed to with Raines, and it was a provision Fannie Mae could not accept. Raines made that clear when he testified to Oxley’s committee on September 25. Oxley was hoping to draft consensus legislation, but with Treasury and Fannie Mae on opposite sides, he was forced to admit that the program approval issue was “still kind of out there.” The committee, he said, would have to make a call on it before the revised version of HR 2575—the Secondary Mortgage Market Enterprises Regulatory Improvement Act—was marked up in early October.

Markup never took place. The administration learned that Oxley and Baker had agreed to leave program approval with HUD to make HR 2575 more palatable to Democrats, and on October 7, the day before markup was scheduled, it withdrew its support of the bill. A spokesperson for the administration, Treasury Assistant Secretary Wayne Abernathy, was quoted as saying that HR 2575 was “not a credible bill,” and that the administration “doesn’t support sending the legislation to the House floor in its current form because it isn’t strong enough to achieve the goal of making the markets safer and more secure.”

It was revealing that the administration’s about-face on the GSE legislation was announced and explained not by Secretary Snow or Treasury Undersecretary of Domestic Finance Peter Fisher but by Abernathy. Abernathy had been assistant secretary for financial institutions, under Fisher, only since December 2002. He had come to Treasury after 20 years on the staff of the Senate Banking Committee, where he had been a protégé of Senator Gramm. Gramm said at Abernathy’s nomination hearing, “For all practical purposes, when I was chairman, Wayne Abernathy was chairman of the committee.” Senator Sarbanes commented at that same hearing, “The Republican economist of the committee—I always thought it was Senator Gramm, but it was really Wayne Abernathy,” adding, “Wayne has been involved in every major piece of legislation which has been considered by the committee since 1981.” That legislation of course included the Gramm-Leach-Bliley repeal of Glass-Steagall in 1999—and the 1992 GSE legislation.

Abernathy’s sudden appearance as the official administration spokesman on GSE issues spoke volumes about the internal politics at the White House. Snow’s draft testimony, when circulated broadly by the NEC among economic policy types within the administration, had set off alarm bells. Fannie Mae was threatening to repeat what we had done in 1992: convince Congress to pass legislation that would simultaneously make us stronger and close off the most promising avenues our opponents had for curtailing our influence. None of the top economic officials in the Bush administration at the time—Snow and Fisher at Treasury, Steve Friedman at the NEC (who as a former Fannie Mae board member had recused himself from GSE issues), or Josh Bolten at the OMB—had particularly strong views on Fannie Mae. But many people within and outside their organizations did, as did FM Watch, its members, and supporters. When those people made their arguments to White House Chief of Staff Andy Card for why opposing us would be good politics as well as policy for the Bush administration, Card came down forcefully on their side. Minority home ownership notwithstanding, opposing Fannie Mae would be a White House priority going forward.

The administration’s opposition to the Oxley bill effectively killed it. Both sides maintained publicly that their remaining differences could be worked out, but in reality we were moving further apart. The focus of the administration’s efforts already had shifted to the Senate, where Banking Committee Chairman Shelby was putting together his own version of a GSE bill.

As late as September 17, Charles Gabriel of the Washington Research Group—who widely was viewed as the best-informed and most savvy observer of the GSE political scene—had written to his subscribers, “The Bush Administration has given no public or (I believe) private hints that it feels the GSEs should be throttled (particularly before Election Day 2004).” The ink was barely dry on that statement when it no longer was true. Right around that time, the White House formed a working group on GSE issues, headed by Card. That group sanctioned and served as the focal point for a now much more aggressive and visible set of anti-GSE activities that extended beyond the administration to include the spectrum of our opponents and critics.

Abernathy appeared at an event at the Heritage Foundation, a conservative think tank long critical of Fannie Mae, on October 22. Joining him there was Peter Wallison of the American Enterprise Institute, another prominent Fannie Mae critic. Wallison called for Fannie Mae privatization, and Abernathy acknowledged in his speech that the White House would lose a vote in Congress on its top priorities for GSE regulation but said it would not back away from them. Then, responding to a reporter’s question, he said the administration would be open to discussions about removing Treasury’s $2.25 billion backstop. News of this statement roiled the market for Fannie Mae debt, and given the reaction to a similar comment by Gary Gensler in 2000, it seemed to have been a deliberate provocation. Later that day, Raines wrote Snow a letter expressing his disappointment with the episode and saying to Snow that he “hope[d] we can change course.”

But the course had been set, and more members of the administration were following it. In early November, the chairman of the President’s Council of Economic Advisers, Greg Mankiw, gave a speech to the Conference of State Bank Supervisors about GSE reform. After running through the now-standard talking points about Fannie Mae and Freddie Mac’s charter benefits, size, and risk, Mankiw detailed the authorities the administration wanted for the new government-sponsored enterprise regulator. He noted three that were familiar—permanent funding, broad authority to set risk-based and minimum capital standards, and authority to reject new activities—and then added an element not in the Oxley legislation but about to be requested in the Shelby bill: “receivership powers necessary to wind down the affairs of a troubled GSE.” Mankiw dismissed the impact the proposed GSE reforms might have on the housing market, saying, “If the housing GSEs were to lose some of their implicit subsidies, private financial institutions would eagerly step in.”

Senator Shelby said in January that before producing a final version of his bill, he wanted to hold hearings in February to solicit a range of views on GSE reform and regulation. He specifically mentioned Fed Chairman Greenspan as one of the people he wanted to hear from. A spokesperson for Shelby said, “[Greenspan] has already made it clear that he has some important viewpoints on this matter. He’s a recognized expert in many areas, and it would be important to get his input.” Greenspan had made numerous comments about the government-sponsored enterprises and GSE reform since the first Baker bill in 2000, all of them carefully crafted to indicate support for restraining Fannie Mae and Freddie Mac while avoiding endorsement of any specific action. His Senate Banking Committee testimony would be different. Since the administration had taken off the gloves with the GSEs, he would as well.

Greenspan’s Senate testimony was scheduled for February 24, and the day before, he went out of his way in a speech to the Credit Union National Association to question the wisdom of consumers’ preference for financing their homes with 30-year fixed-rate mortgages—the loan type that comprised over 90 percent of Fannie Mae’s mortgage portfolio and mortgage-backed security guarantees. He told his audience, “Homeowners pay a lot of money for the right to refinance and for the insurance against increasing mortgage payments,” adding, “Recent research within the Federal Reserve suggests that many home owners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.” (In hindsight, yes; interest rates had fallen for the last 20 years.) He went on to counsel, “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional mortgages.”

Reading about these comments at the time, I was astonished. The new “alternative” mortgage products Greenspan was touting already were flooding into the market, and many of them we either wouldn’t finance because we thought they were too risky or we couldn’t finance because the private-label securities market was underestimating their risk and outbidding us for them. Greenspan’s comments about adjustable and fixed-rate mortgages, I thought, were so wildly off base economically that they must have had a purpose politically.

They did. They were the first of the three-part litany developed by FM Watch four years earlier: the GSEs don’t do much for housing, they’re risky, and something must be done about it. Greenspan added the rest in his Senate Banking Committee testimony. He framed the risk issue this way:

The “special advantage” was our federal charter and the implicit guaranty accorded to our debt by investors. What to do about it? Greenspan dismissed the possibility of disciplined risk management as a solution to his concern with the overstated claim that “the current system depends on the risk managers at Fannie and Freddie to do everything just right.” Instead, his prescription was, “Our financial system would be more robust if we relied on a market-based system that spreads interest rate risks, rather than on the current system, which concentrates such risk with the GSEs.”

To no one’s surprise, Greenspan’s primary recommendations for government-sponsored enterprise reform were the same the White House was advocating: “In sum, Congress needs to create a GSE regulator with authority on a par with that of banking regulators, with a free hand to set appropriate capital standards, and with a clear process sanctioned by the Congress for placing a GSE in receivership.” But he had a further recommendation of his own:

With that, his secret was out. Effective risk management could not overcome Greenspan’s objections to us, and even “bank-like regulation” would not be enough. There had to be federally mandated limits on the size of our portfolio.

Greenspan’s testimony stripped away the pretense that there could be any such thing as consensus GSE legislation. What the Bush administration, the members and supporters of FM Watch, and Greenspan all wanted from the Shelby bill were mechanisms that could be used to our disadvantage. Having begun the legislative process in the spring of 2003 in good-faith negotiations with Secretary Snow on the content of the Baker-Oxley bill, in early 2004 we found ourselves furiously playing defense to stop provisions we opposed from being put into the Shelby bill against our will. And the provision being pushed the hardest by the administration was the one we objected to the most—receivership. For us, receivership was a poison pill. A safety and soundness regulator housed in Treasury, under Treasury control, and with receivership powers could liquidate Fannie Mae for any reason. We couldn’t possibly agree to that.

Receivership was an idea that began with Treasury and had been endorsed by the administration and Greenspan. It never had been on the FM Watch agenda. None of our competitors were pushing for it. They wanted Treasury to have more control over us—so they could earn more profits at our or consumers’ expense—but they wanted us to remain in business. Talk of a receivership provision also worried the rating agencies. Standard & Poor’s, Moody’s, and Fitch all were watching the Shelby bill closely for signs of a change in the relationship between the GSEs and the government, and all warned that evidence of such a change could trigger a downgrade on our debt. Fitch and S&P specifically singled out receivership as a source of concern. S&P’s Mike DeStefano stated the obvious: “Giving the regulator that kind of power over the GSEs is not a good thing for debt holders.”

Receivership became the battleground in the Shelby bill. To get a bill through his committee, Shelby was forced to accept an amendment by Republican Bob Bennett of Utah (whose son headed Fannie Mae’s Utah partnership office) requiring that the new regulator give Congress up to 45 days to reverse any decision it made to place a GSE in receivership. With that amendment, on April 1 Shelby’s bill passed narrowly, 12 to 9, on a near party-line vote. Only Democrat Zell Miller from Georgia voted with the Republicans.

The bill would have faced a bitter partisan fight on the floor, but it never got there. Once again, the Bush administration pulled its support from the legislation. In a joint statement, Secretary Snow and HUD Secretary Alphonso Jackson said the amended bill “is now unworthy of the reform efforts.” The administration was walking away from GSE legislation over a provision that had not even been contemplated in the Oxley bill six months earlier, from which it also had walked away. The goalposts were moving, and Shelby was not happy about it. He badly wanted to get a bill done. Shelby said he would continue to press for GSE reform in the Senate, but he did not sound optimistic about its prospects. “It’s on the calendar,” he said. “We’ll see what happens.”

Operation Noriega

The administration already had decided on a different approach. Its next move was spelled out with remarkable candor in a front-page article on April 28 in the Wall Street Journal titled “Regulators Hit Fannie, Freddie with New Assault.” The article began, “Frustrated by its inability to win congressional approval to tighten regulation of mortgage giants Fannie Mae and Freddie Mac, the government is pursuing the same goal through regulatory fiat.” It explained:

The administration had an internal nickname for these efforts, Operation Noriega. It was a reference to the harassment strategies the U.S. military used against former Panamanian strongman Manuel Noriega, in which it blasted loud rock music at him nonstop to dislodge him from his refuge at the Vatican embassy and get him to surrender. The administration’s GSE version ranged from minor harassments to major onslaughts. Included among the harassments were an inquiry by the Internal Revenue Service into possible misuse of the Fannie Mae Foundation, an examination by the Department of Labor of the structure and investments of our 401(k) plan, and a review by HUD of whether the consulting work done by our International Housing Finance Services Group—a five-person operation in existence for 15 years, which took on many of its assignments at the request of the State Department—was within the scope of our charter. The more serious and consequential actions were taken by Treasury, by HUD on affordable housing, and by OFHEO.

Fannie Mae’s charter act contained a provision that said, “The corporation is authorized to set aside any mortgages held by it . . . and, upon approval of the Secretary of the Treasury, to issue and sell securities based upon the mortgages so set aside.” For all of Fannie Mae’s history, we and Treasury had interpreted this provision as giving Treasury what we both referred to as “traffic cop” authority—making sure our planned debt issues did not interfere with theirs. Abernathy began telling the press that the approval provision in our (and Freddie Mac’s) charter could be interpreted as giving Treasury the ability to set absolute limits on our debt issuance. We disagreed with that interpretation. Everyone consulted with their lawyers, and in July Treasury said that the Justice Department had given them a legal opinion that they could limit our debt issues for safety and soundness reasons or to protect the financial markets.

Treasury did not act on this opinion, however. Perhaps that was because they intended to use the threat of limiting our debt issuance as negotiating leverage in future legislation. But it also may have been that reality had intervened. Our portfolio—which critics insisted would grow uncontrollably unless the government did something to restrain it—was in fact three percent smaller in July 2004 than it had been in September 2003. Away from the political world, financial market conditions had changed drastically since our legislative discussions began the past spring. We were losing share to the private-label securities market, and spreads between mortgages and our debt costs had tightened to the point where there were many fewer portfolio purchase opportunities than there had been previously. Our critics, including the Fed chairman, might not have accorded much importance to our risk disciplines, but they were having a pronounced effect on our business.

HUD’s major contribution to the regulatory assault was significantly higher affordable housing goals for Fannie Mae and Freddie Mac for the years 2005 through 2008. In May, HUD proposed a series of increases in the percentage of our business we were required to do with low- and moderate-income borrowers, from 50 percent in the 2002–2004 period to an eventual 56 percent in 2008. Even greater relative increases were proposed for our underserved area and special affordable housing goals, and a new set of home purchase subgoals was added as well. We were not an originator and could buy or guarantee only what our lenders offered to us. HUD’s proposed affordable housing percentages were well above the percentages our lenders were originating (although HUD claimed they were not). I believed at the time that one of the rationales for boosting the goals so much was to force us to cut back on the amount of the business we did that was not goals-eligible. Many of my colleagues agreed with this assessment; they called it “using the numerator to control the denominator.”

The White House had tried to replace Armando Falcon as director of OFHEO in 2003, but the nomination of his proposed successor, Mark Brickell, had stalled in the Senate. That was a fortunate break for them. On January 21, 2004, the White House withdrew Brickell’s nomination without telling him, leaving Falcon in place. OFHEO was in the best position of anyone to make our lives difficult, and Falcon was perfect for the job. His dislike of Fannie Mae had gone beyond the institutional; he felt Raines and other company executives, including me, did not respect him. (We thought he was a very poor regulator, but it was never personal.) For Falcon, allying with the administration’s crusade against the GSEs was a path not only to getting himself and his agency back in its good graces but also to settling a score. He eagerly followed it. When the administration abandoned its efforts on the Shelby bill over its compromise receivership clause, Falcon began working on a regulation that used an existing OFHEO authority to create what he called a “liquidating conservatorship” for us and Freddie Mac that he contended could have the same effect as receivership. Falcon also had launched a review of Fannie Mae’s accounting and was saying publicly that he believed this review would find irregularities that would require us to restate our earnings.

Faced with the bleak prospect of unrelenting opposition from the Fed, the Treasury, HUD, and OFHEO, in the spring of 2004 we again undertook a serious study of potential changes to our business structure, including full privatization. We retained Goldman Sachs for this project, which I led. Our efforts focused on the portfolio business, the bête noire of our critics. With Goldman we looked at a large number of restructuring possibilities, including spin-offs, nonagency subsidiaries, changing the portfolio to a REIT, and breaking the portfolio into smaller independent units. We also considered Sallie Mae–style privatization. We had a full discussion of all of these alternatives with our board in July of 2004, but as was the case with the Maxwell privatization efforts in the 1980s, we could not come to agreement that any one of them would be better for our stakeholders—home buyers and our shareholders—than our current structure.

As the year came to a close, we knew we had to do something to appease our critics. We did not want to give in on minimum capital because that was a slippery slope that could lead to our business becoming uneconomic, but we were increasingly open to a negotiated limit on the size of the portfolio.

The parallel worlds of Fannie Mae never were more divergent than in 2004. In our political world, we were desperately trying to fend off legislative and regulatory assaults by critics who claimed that the interest rate risk of our mortgage portfolio—which had been kept well under control for the past two decades and just reduced further through our 2003 risk disciplines—posed grave threats to the financial system. At the same time, in our business world, we were scrambling to protect ourselves against the greatly increased credit risk of the new mortgage products and risk combinations now prevalent only because they could be financed through the private-label MBS mechanism promoted and supported by the very group of critics attacking us in our political world.

Our political critics never raised the size and credit risk of our MBS guaranty business as issues. To the contrary, Greenspan had concluded his February Senate Banking Committee testimony by saying:

For years, Fannie Mae’s adversaries, including Greenspan, had convinced themselves that GSE interest rate risk was the only mortgage risk that posed any danger. Now there was a real risk looming right in front of them, largely of their own making, and they simply didn’t see it.