I’m going to get into three things with you this morning.
First, I’d like to address the issues raised by many respected people, in regard to the suppression of private interests by an agency of government. To do this, I'm going to fill in some of the history of Fannie and Freddie.
Second, I'll give more detail on the exact terms of the Treasury takeover of the GSEs, Fannie Mae and Freddie Mac? What’s going to be happening, and when does it expire?
Third, we’ll talk about what is happening in Congress, now that they’re back from summer vacation.
The entry of Fannie Mae and Freddie Mac into government conservatorship is an action being taken pursuant to a grant of emergency powers to the Department of Treasury, by the Housing and Economic Recovery Act of 2008, signed into law by President Bush in July.
The emergency powers were inserted hurriedly into the legislation at the behest of Secretary Paulson over a weekend in July, after global investors had endured a week of extreme tension and concern over certain securities issued by the GSEs.
Fannie and Freddie were originally created by the Federal Government, not by the private sector. They were never private entities in any meaningful sense of the term. (I’ll come back to this point.) Their goal was not to enrich private shareholders. Rather, it was to support the secondary mortgage market, and thus promoting homeownership, by purchasing mortgages that had been guaranteed by other Federal agencies.
When Congress privatized Fannie in 1968 (spinning out Ginnie Mae as a separate, fully government-controlled entity in the process) and created Freddie in 1970, they started greatly expanding their activities.
Congress never unambiguously provided that the debt and securitizations issued by either GSE would be federally guaranteed. Nevertheless, they did have a funding advantage that private entities never had, amounting to perhaps a couple dozen basis points, as a result of the “implicit,” ambiguous Federal guarantee. Their regulatory capital requirement (0.45% of assets exposed to credit risk) was also far smaller than comparable private organizations like banks, which gave them yet another edge in the market.
Congress was fine with this, as it appeared to support the social goal of expanding home ownership by making mortgages a little cheaper.
As the years went by, Fannie and Freddie were able to convert these government-conferred advantages into a commanding and insurmountably dominant position in the US mortgage market. There is no private market of any significance for conformant mortgages outside the context of Fannie and Freddie today.
To say that the takeover amounts to a transfer from the private sector to the public sector is to misread the reality of the mortgage market.
And then Fannie and Freddie started using their power to move into more markets, always looking to increase earnings for their shareholders. They went into technology, intellectual property, securitizations of mortgage products, and other kinds of investments, including securitizations and guarantees of subprime mortgages.
You’d do the same if you were a private company looking to expand your top line and your bottom line, and generally to get a bigger footprint in the world.
But most private companies don’t benefit from statutory impediments to competition. Protected not only by Congress’s laws but also by close personal and lobbying relationships with key lawmakers across the years, Fannie and Freddie were never forced to come clean about the risks they were taking.
They went through an ugly spasm of scandal in 2004 which resulted in restatements of earnings, withdrawal of audited financial statements, and the dismissal of their then-CEOs.
And now that everything is blowing up around them, and even their conformant-mortgage portfolios are taking losses, the time came to pull the plug.
Now pay close attention to this: Fannie and Freddie, although very deeply compromised by their very nature, never posed enough of a systemic risk to mess with, as long as they were making money for their shareholders.
This is certainly a story of private interests being wiped out by a government takeover, but anyone making that case needs to justify that those private interests really should have been so enriched over the years, by way of a set of opportunities that only existed because Congress created it.
And now that Congress is back in town, the recriminations have started. (It certainly seems like an odd coincidence that the takeover should have been completed just before Congress got back.)
Already there are reports that Sen. Dodd of Connecticut (and the recipient of personal consideration from Countrywide Mortgage Company) is planning to blame the eight years of the Bush Presidency for the failure to act on Fannie and Freddie until now.
Much more to the point (and much more intelligently), Rep. Barney Frank has already begun to engage the substantive policy issues that the takeover activates, which come down to this: should the government continue to subsidize private mortgages at all? And if so, then is the goal best served by revitalizing Fannie Mae and Freddie Mac? Or should we hand all of this off to the private sector?
Discouragingly, Frank has already tipped his hand, hinting that he would not be in favor of mandating that Fannie and Freddie allow their portfolios to run off over time and not be replaced with new obligations.
In the meantime, other Senators and Members of Congress are voicing the opinion that Secretary Paulson knowingly lied to them, when he said that he didn’t expect to use the emergency powers he asked for five weeks ago. Expect some contentious and possibly ugly hearings coming up.