New York Fed chief calls for mortgage reform

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A US banking chief called on Thursday for a “fundamental rethinking” of Fannie Mae and Freddie Mac following the Bush administration’s plan to shore up the mortgage groups with government funds if necessary.

“The current balance is probably untenable over the longer term,” Tim Geithner, president of the Federal Reserve Bank of New York, told legislators on the House financial services committee.

“I believe there is going to have to be a fundamental rethinking of the future of these institutions.”

Fannie Mae and Freddie Mac have long benefited from investors’ confidence that the government would step in to save the two mortgage companies in a crisis.

But this implicit guarantee became far more explicit on July 13, when the Treasury department said it would seek powers to increase its credit line to the two and invest in their equity. On the same day, the Federal Reserve opened access to its emergency cash facility for the two groups.

Mr Geithner’s comments suggest that policymakers, legislators and investors in Fannie and Freddie might soon start clamouring for greater clarity about the relationship between the government and the two companies, given the additional guarantee implied in the rescue.

On the day the plan was announced, officials had said Fannie and Freddie should continue to operate in their “current form” for the foreseeable future – as private companies chartered by the government but owned by public shareholders.

Mr Geithner also gave warning on Thursday that the Fed could not deal with all the economic challenges facing the US today – making it clear that the government had an important role to play as well. “Monetary policy cannot bear the sole responsibility of responding to those challenges,” he said.

Some Fed officials think the government should play a larger role in ensuring the continuing flow of reasonably priced housing loans and possibly help to recapitalise the banking system as well.

Mr Geithner said the financial system had to be made “more robust to very bad outcomes and more resilient to shocks”.

But he spoke against the Treasury plan to take away the Fed’s role as a direct supervisor of large banking groups in return for giving it a new roving authority to deal with systemic risk.

“Replacing our ongoing role as consolidated supervisor with standby, contingent authority to intervene would risk exacerbating moral hazard and adding to uncertainty about the rules of the game,” he said.

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