Since 2012, the U.S. seems to be business as usual. Stocks have been climbing, the “too big to fail” banks have basically paid back their government “bail out” money. The housing market has boomed, with too few homes to go around, causing much higher demand for rentals.
Unfortunately, this has resulted in some renters having to pay 50% of their income for housing – compared to the 15.3% home owners pay for their housing bills. Zillow, the rental guru guide claims that we are in a rental crisis.
The discomfort about housing has brought to the forefront the debate over GSEs (government sponsored enterprises), of which Fannie Mae and Freddie Mac are at the center. Congress has long debated replacing Fannie and Freddie, who were at ground zero of the 2008 crisis as federally charted privately owned companies. They’d been given directives by Congress to make housing affordable, which pretty much meant: fulfill the American dream by having a chicken in every pot, a car in every driveway and a home for every American family – whether they could afford it or not.
And so the push was on to make housing affordable for everyone, almost regardless of their ability to pay. I strongly believe that one of the primary reasons Fannie and Freddie had such catastrophic losses was not that they had purchased mortgages with loose credit criteria at the behest of Congress, but that they purchased many, many mortgages which did not even meet that low bar of creditworthiness. That is, they did not review the individual mortgages but relied almost solely upon false certifications by the sellers that the mortgages sold met the published standards. It was a perfect storm: a lack of controls, the implicit guarantee the government would stand by the loan, and the assumption that the institutions doing the lending wouldn’t go under. No one was checking. It was a circus!
The more mortgages were purchased, the more incentives went straight to Fannie and Freddie. After all, they met the requirement Congress had laid out for them.
Everyone met their quota, everyone made money, everyone – including shareholders – were happy. After all, why not? It was free money.
But, all good things come to an end. And in 2008, the house of cards came tumbling down into the worst recession since the ‘30’s. The government placed Fannie and Freddie in conservatorship, and bailed Fannie and Freddie out to the tune of $187.5 billion in senior preferred stock. And, just as the Too Big To Fail, with their monetary injections, started back on the road to recovery, so eventually did the GSEs- Fannie and Freddie. By the second half of 2012, they posted $8 billion in profit.
Now Fannie and Freddie have a unique structure. As GSEs, they are federally chartered, yet privately owned, with shareholders expecting a return on their investment. That’s business, and Freddie and Fannie are in the top 50 Corporations in the U.S.
But in late 2012, something very odd happened. Two arms of government, the Treasury Department and the Federal Housing Finance Agency,“agreed to radically change the terms of what the GSEs would owe in exchange for the moneys they had already received.” Instead of a 10% annual dividend on all the bailout moneys drawn, the dividend was now at 100% of each GSE’s net profit, which meant any and all profit Fannie or Freddie posted, belonged to the U.S. government. Essentially, Fannie and Freddie were nationalized.
The change, called the “Third Amendment,” became effective in January 2013. And another funny thing happened: the GSEs started posting the highest profits they’d ever received – ever. The billions posted went straight to the Treasury. The amount of preferred dividends paid to the government is now about $240 billion, a nice return on the $187.5 billion or so the government had originally invested.
And, it gets worse. The government did not allow for Fannie and Freddie, in the terms outlined for payment, to pay back the principal. Which means that if the GSE’s are dissolved, the government will take the first $187.5 billion recovered from liquidation before the original preferred shareholders collect a dime.
Well, the GSE shareholders are up in arms, from private investors to mutual funds to insurance companies with suits flying left and right who allege the U.S. government illegally or unconstitutionally took, without compensation, two Fortune 50 companies, Fannie Mae and Freddie Mac. The money in question, $33 billion in preferred shares and close to $130 billion in dividend payments in excess of the original 10% dividend rate. The battle over the government’s alleged nationalization is huge.
“A conservator has one constant accepted responsibility,” says Chuck Cooper of Cooper & Kirk, a D.C. firm which is handling two of the cases involved and advising on a third; “That is to rehabilitate the entity under conservatorship. Rehabilitate it. Not to hold it in perpetual captivity to harvest its profits for the benefit of the conservator itself. That’s the very antithesis of a conservator.” Well, the GSEs are now into their seventh year of conservatorship with no plan and shrinking capital reserves. In essence, they are in a state of crisis.
This move on government’s part, that of nationalizing two privately owned companies, is unprecedented. It being an election year, the debate has become highly political; with some calling for the demise of the GSEs and some saying we now need them more than ever. But more than that, the GSE stock evaluations are worth nearly nothing. And, some investors are complaining about an alleged take over of the companies which occurred even before many of the current investors bought in.
Are we missing something here? Or, did they sense this would become a circus and the profits would be huge? Is greed, once again, running rampant?
Fund managers want to influence policy making by recapitalizing and restructuring Fannie and Freddie to their prior positions. By the way, this move would greatly maximize their share value, so let’s not confuse this outcry on their part with community service, largesse or altruism.
The arguments for capitalization and restructuring, as well as arguments to dismantle the GSEs, are polarizing. Sen. Bob Corker (R-Tenn), said, “There’s a majority of people here that believe that they should be wound down and replaced so that the taxpayers are not backing them up as they are today.” Many vocal leaders hate the GSEs and are downright vitriolic in their dislike of the government takeover. Yet, both the voices for and against dismantling, have merit.
One of those voices, Bethany McClain, author of Shaky Ground: The Strange Saga of the U.S. Mortgage Giants, comes down on the side of fund managers. She says, “One of the investors gave me the analogy that Corker-Warner was like taking the existing highway structure in the U.S., tearing it up, and building a new one right next to it, with no guarantees that the new one was going to work.”
Well, some of the free market arguments make no sense regarding starting over, if the government is still going to offer guarantees. As Bethany McClain tells us in a recent Washington Post op-ed, “free market solutions assume that the big banks would take greater control of the mortgage market without Fannie and Freddie. But the big banks were bailed out in 2008, too. The Dodd-Frank financial reform legislation may have fixed the “too big to fail” issue. (That’s debatable, but give it the benefit of the doubt.) If banks control the nation’s mortgage market, does anyone think they’ll be allowed to fail in the next crisis? In which case, how are they not government-supported entities, as well?”
For 80 years, Fannie and Freddie’s role has been to promote home ownership. They made possible the 30 year, fixed, prepayable mortgage and while they were eventually misguided, they did promote liquidity in the mortgage market by buying mortgages, bundling them into securities and selling them, thinking – albeit falsely, they had government guarantees.
The government claims the GSEs are nowhere close to paying back the bail out moneys they were paid. But the records of depositions from officials at Treasury and the FHFA seem to show that the government’s story is misleading and in some cases downright false.
And to “protect” the public and not place this nation’s financial markets in jeopardy, would you believe the documents have been sealed from the public’s view? So the public is too delicate to see how the government is using their money? Folks there is something not quite right about all of this. And we’d best start asking more questions before we rush into changes that may be worse.
[tweetthis]Is the public too delicate to see how the government is using their money? ~@RichardMBowen #tbtf #fannie #freddie [/tweetthis]
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