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11th July 2008, 17:20

Snow Says Fannie Mae, Freddie Mac Followed `Hedge Fund' Model

By Brendan Murray

July 11 (Bloomberg) -- Former U.S. Treasury Secretary John Snow said that Fannie Mae and Freddie Mac have relied on leverage to fund their businesses in the same fashion as a hedge fund, and that the government should avoid taking them over.

``Congress ought to be embarrassed'' for years of delays in passing legislation aimed at strengthening regulation of the two companies, Snow, now chairman of New York-based buyout fund Cerberus Capital Management LP, said in a telephone interview. He said he suggested when in office that ``the business model they were using was really the model of a hedge fund.''

The government-chartered companies, which grew to account for almost half of the $12 trillion in U.S. mortgages, were able to borrow at cheap rates because of an implicit federal guarantee, Snow said. His opposition to a full government takeover echoes the signal sent today by his successor, Treasury Secretary Henry Paulson.

``The most important thing is that the systemic risks that those institutions present get dealt with,'' Snow said. ``They play such an important role in the secondary mortgage markets, but it's coming at such a high cost in terms of potential blowup of the whole financial system.''

Paulson has urged Congress to pass legislation setting up a new, strengthened regulator of Fannie Mae and Freddie Mac. Senator Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said in a press conference today that he expects legislation including the measure to be sent to President George W. Bush for signing next week.

`Not Be an Option'

Paulson said in a statement today he wants the companies to remain in their ``current form.'' Snow agreed that ``nationalization should not be an option.''

Snow, who served at the Treasury from February 2003 to June 2006, said because Fannie Mae and Freddie Mac operated under federal charters, there's an implied guarantee of their debt that shouldn't exist. He said during his Treasury tenure he pointed out the two were ``arbitraging their lower borrowing costs that came about because of the implied status as government entity.''

Fannie Mae and Freddie Mac make money by borrowing in the bond market and reinvesting the proceeds in higher-yielding mortgages and securities backed by home loans.

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, implying the government will stand behind the companies' debt.

`Fundamental Problem'

``If I were in a public policy role, I'd be focusing attention on what has long been known to be the fundamental problem of risks to the balance sheet of the United States that are gigantic,'' Snow said.

In October 2003, Snow and Fannie Mae's then-Chief Executive Franklin Raines debated in a Senate hearing whether the Treasury should have the authority over new loan products. At the time, the government-sponsored enterprises were under scrutiny from the Treasury and other regulators to because of errors in accounting.

``Congress should not open the door for the regulator to prescribe, outside the necessities of safety and soundness oversight, how the enterprises conduct their business,'' Raines said. Snow said the new regulator was needed to ensure financial stability, adding that ``We don't face in my view any current crisis, but we never want to get close to the point where we would face that problem.''

Snow said today that ``even in the face of the scandals over compensation and accounting and the options and bonuses, we never could get Congress to cross the line.''

Fannie Mae and Freddie Mac ``have an enormous political organization, lots of reach into many congressional districts, and they had a storyline that at the time worked -- they were really promoting housing,'' he said.