The True Nature of Fan and Fred

Last Wednesday, WSJ had a great article called "The Fannie Mae Gang" by Paul A. Gigot, as linked here.

It had good discussion on another aspect of the current mortgage crisis,  and the roles and responsibilities of many players dated back many years ago. It showed us the inner circle of the secret "Skull and Bones" society around Fannie Mae (FNM) and Freddie Mac (FRE). It detailed among, for example, former Fannie Mae Chairman Franklin Raines, former Countrywide Financial CEO Angelo Mozilo and House Financial Services Committee Chairman Barney Frank that have helped create the monsters called Fan and Fred:

I recount all this now because it illustrates the perverse nature of Fannie and Freddie that has made them such a relentless and untouchable political force ... The abiding lesson here is what happens when you combine private property with government power. You create political monsters that are protected both by journalists on the left and pseudo capitalists on Wall Street, by liberal Democrats and country club Republicans. Even now, after all the dishonesty and failure, Fannie and Freddie could emerge from this taxpayer rescue more powerful than ever.

There are probably few things more disturbing and scary than this.

Back in 2002, WSJ had an article called "Fannie Mae Enron?", questioning their shaky derivatives accounting. And the person who was angry about the article, obviously besides the then-CEO of Fannie, Mr. Raines, was surprisingly then the CEO of Countrywide, Mr. Mozilo. Mr. Mozilo loudly insulted Paul Gigot by stating he knew nothing about accounting or mortgage markets, among other things. Apparently Mr. Mozilo and Mr. Raines were partners, with Countrywide feeding mortgages to Fannie to make Mr. Mozilo very rich. Of course, he got to protect his most valuable customer.

Thanks to their quasi-public and quasi-private dual structures, Fan and Fred can borrow from the government at super-low interest rates, enjoyed the spread between such low borrowing rates and much higher mortgage rates in their portfolio originated from Mr. Mozilo and others. If that is not enough, Fannie was creating shaking derivatives from these mortgages to generate more profits, which brought the above WSJ article that compared Fannie to Enron. No wonder Mr. Mozilo was angry, so was Mr. Raines, since regulator James Lockhart later on discovered that Fannie had rigged its earnings in a way that allowed it to pay huge bonuses to its executives, especially Mr. Raines who was forced to resign.

Then FOM (friends of Mozilo) in Congress quickly came to the rescue. First, Republican Rep. Cliff Stearns of Florida was stripped of his subcommittee of jurisdiction over Fan and Fred's accounting by House Speaker Dennis Hastert. Then Barney Frank was taking over the whole show to protect Fan and Fred from stronger regulatory oversight. When Wisconsin Rep. Paul Ryan advocated more supervision for Fan and Fred, Fannie played hardball by calling every mortgage holder in his district, claiming that Mr. Ryan wanted to raise the cost of their mortgages, in . Ryan receiving 6,000 telegrams. He left the Financial Services committee for a seat on Ways and Means, which of course doesn't oversee Fannie anymore.

In addition, the "Fannie Mae Gang" article wrote, "Fan and Fred also couldn't prosper for as long as they have without the support of the political left, both in Congress and the intellectual class. This includes Mr. Frank and Sen. Chuck Schumer (D., N.Y.) on Capitol Hill, as well as Mr. Krugman and the Washington Post's Steven Pearlstein in the press........Yet as studies have shown, about half of the implicit taxpayer subsidy for Fan and Fred is pocketed by shareholders and management. According to the Federal Reserve, the half that goes to homeowners adds up to a mere seven basis points on mortgages. In return for this, Fannie was able to pay no fewer than 21 of its executives more than $1 million in 2002, and in 2003 Mr. Raines pocketed more than $20 million. Fannie's left-wing defenders are underwriters of crony capitalism, not affordable housing." This is similar to some charities that use half of the donations for their "expenses" and only pay out half to the claimed causes.

Fast forward to today. Taxpayers not only have paid so much and so dearly to support this crony capitalism of friends of Mozilo, but also have to inject more capital into Fan and Fred, in addition to guaranteeing their trillions in debts issued in the past, many of which should not have been issued and are now held by foreign governments of our trade partners in their currency reserves. Talking about global crony capitalism among goverments, which really leaves U.S. taxpayers with no choice. This is really the beauty of quasi-private and quasi-public dual structures. Profits go to the few Skull & Bones, while losses are dumped to the whole society, and all is done in the name of "helping poor people to own houses".

The best part of this WSJ article is that one analyst at Sanford C. Bernstein, a Fannie apologist, wrote in 2002 about  the "Fannie Mae Enron?" article, "Taxpayer Are on The Hook: This is incorrect. The agencies' debt is not guaranteed by the U.S. Treasury or any agency of the Federal government." Maybe his great insight from six  years ago was partially correct, since we are going down the road from "too big to fail" to now "too big to be guaranteed".

 

Comments

[mals:]

A piece of trash, if I ever read one. This one is pure right wing gibberish.

2008 Jul 30 07:11 PM

[mals:]

Pure right wing gibberish

2008 Jul 30 07:12 PM

[DCBill:]

Anyone thinking Mr. Tan hasn't anything valid to add to this discussion should stop after reading his first major point--which is so erroneous, it defies categorization. (And anyone who thinks Mr. Ran is correct knows less than that gentleman!)

Thanks to their quasi public and quasi-private status, Fan and Fred can borrow from the government at super low interest rates...."

Really, Mr. Tan?

When did Fannie or Freddie EVER borrow one dime from the US Government? When did the US Traesury ever pay off one of the debt holders? When did the smallest amount of GSE mortgage activity ever show up in the US Budget--of any Administration, Republican or Democrat?

The GSEs borrow on their own in the national and international debt markets. Their debts--in the hundred of billions always have been honored--with the lion's share of their income comign from interest on the mortgages and securities they hold, plus profits.

Mr. Ryan left the the Financial Services Committee to go to Ways and Means.

Ask any DC lobbyist or Member and you'll find that the W&M committee is a "plum" assignment, an exclusive committee which permits service on no other, because of its importance and because its jurisdiction (tax, federal health policies, etc) is so broad. The industries which lobby Ways and Means spend generate thousands upon thousands of dollars in campaign contributions, far more than anyone who serves on House Financial Services.

That's a dirty little "inside the Beltway secret," but that is why Members flee any assignment they have when a spot on the tax writing committee beckons.

Mr. Tan knows little or nothing about which he writes!

A Ways and Means seat is sought by many but few get the nod.

The bailotut hat Mr. Tan seems to worry about hasn't ahppened, since neither F/F has asked for or received any federal funds.

No construe Secy Paulson putting in place a "contingency" with a fact that both companeis will avoid like cancer, since it weould eman their deaths as private companies.

2008 Jul 30 07:22 PM

[DCBill:]

Holy "spell check" Batman, maybe I am not as smart as I think--at elast when it comes to doing away with typos.

But, I think you get what I mean!

2008 Jul 30 07:25 PM

[MetalHammer339:]

Mr Tan GREAT article.You really hit it well with 2008 prediction article.

2008 Jul 30 10:21 PM

[whtamess:]

You know that "report abuse" button on the bottom of each commentary... that should be at the bottom of the article. Mr. Tan is completely out of line and borders in the range of flunking on this paper.

2008 Jul 31 11:31 AM

[Jason Rines...:]

How is Mr. Tan out of line? I don't believe he is in any way shape or form. Paulson stated the cost to tax payers could be $25 B or it could be nothing. It also could be $350 B and it likely will be as real-estate asset values drop another 10%. Hey those on the left reading this: 60 M pitchforks. To those on the right: Let me get you braces for your weak wrists.

2008 Jul 31 02:19 PM

[outtafavr:]

Only time will tell which side is ultimately correct about FNM and FRE. Recent history has not been kind to FNM/FRE proponents. The bitterness in the responses of "DCBill" and the other GSE shills remind me of a female bison defending her calf's dead bloated carcass from hungry wolves.

2008 Jul 31 05:15 PM

[kdo:]

I don't believe the responses by DCBill and others are related to "which side is correct" about what will happen to the GSEs. It relates to significant distortions and inaccuracies within the article. If we're going to talk about the GSEs, we should all be able to agree that at least we should have our facts straight and not invent them right?

Let's see the accusations:
1) FNM and FRE are headed by Skull and Bones Society members. Mr Tan says that the WSJ article in fact "showed us the inner circle of the secret "Skull and Bones" society around Fannie Mae (FNM) and Freddie Mac (FRE)".
Funny, cause I read the WSJ article too and I was pretty sure when I read it the first time there was nothing about Skull and Bones secret government running society anywhere in there!! Low and behold, checking it again, I can't find that passage he refers to.
2) Talks about these entities borrowing from the govt.
The GSEs absolutely, do not borrow money from the govt and this fact alone shows enormous disregard for facts or actually knowing what one is talking about. I think it is quite easy to dismiss the article right here because of the fundamental nature of the organization of these entities is not understood, not even remotely.

But let's go on:
3) Let's see: "Apparently Mr. Mozilo and Mr. Raines were partners, with Countrywide feeding mortgages to Fannie to make Mr. Mozilo very rich".
Again, this reeks of lack of understanding the fundamental nature of FNM and FRE. Pretty much ALL banks sold many mortgages to FNM and FRE, because that is their fundamental nature to buy and guarantee loans they are allowed to buy. Mr Mozilo did not have a special relationship in this regard. If the mortgage fit certain criteria, they bought it.
4) "Fannie was creating shaking derivatives from these mortgages to generate more profits,"
While, I'm not exactly sure what a shaking derivative is, I'm guessing Mr Tan doesn't know much about them or what kinds of derivatives FNM might be using either and derivative is just a bad scary word to use. FNM had primary issues in 2002 about it's derivative accounting, of which FNM went through a significant period of time to get results restated. I don't believe there is anyone making those accusations today and that is conflating the issue of what happened several years ago with questions about their solvency today. Details, details.
5) "Yet as studies have shown, about half of the implicit taxpayer subsidy for Fan and Fred is pocketed by shareholders and management"
-- There isn't a subsidy. Taxpayers don't fund FNM. There has been an implied guarantee as a quasi-public entity that has never been tested. That is what this is about. I have my doubts that seven basis points is all the "benefit", but whatever. That's a real study at least by people who know WTF FNM and FRE actually did and is a legit point of discussion unlike anything this article has provided.
6) "Taxpayers not only have paid so much and so dearly to support this crony capitalism of friends of Mozilo"
Well, at least Mr Tan is consistent in his lack of knowledge of the GSEs. Taxpayers haven't paid anything, which says so much about this person's knowledge of the situation surrounding the GSEs. The friends of Mozilo, was funded by Countrywide, but why not conflate various issues to confuse various things people are angry about!?
7) "This is really the beauty of quasi-private and quasi-public dual structures. Profits go to the few Skull & Bones, while losses are dumped to the whole society, and all is done in the name of "helping poor people to own houses".
I wonder if Mr Tan has thought about how well the purely private companies fared in this whole mess? The GSEs couldn't do jumbos or subprime, which are the biggest messes of all.

I have no significant love of the GSEs. The privatization of profits on the backs of an implicit guarantee of the govt is not something I'm wild about in any shape or form. But Mr Tan is not entitled to his own facts and if I ran Seeking Alpha, I'd yank the article, because it is that bad. I'm not saying it's bad because of the opinion, it's the complete lack of understanding of the entities in question.

"Better to keep your mouth closed and be thought a fool than to open it and remove all doubt".

2008 Aug 01 02:44 AM

[tigercpa:]

Amen to DCBill, the only person, so far, that I have heard characterize the F/F situation appropriately.

This has not cost the taxpayers one dime,. and may not ever cost them anything.

So much misinformation and lazy journalism regrading F/F these days.

2008 Aug 01 06:41 AM

[thomast2:]

Thank you all for the comments, even some of them are very harsh and unfriendly ones.

For those who don’t think F/F will cost taxpayer a dime, did Greenspan just call for “nationalized” F/F this week? What’s “nationalized” mean? If not taxpayer’s money, then whose? Yours? Maybe Greenspan meant the Japanese or Chinese central banks? Maybe it is not such a bad idea for foreign central banks to takeover F/F since they own so much of their debt anyway. How about the $25B estimate from Congress for taxpayer’s losses, even it is probably underestimated by 15-20 times as ithinkbig pointed out (I can show some calculations at the next article on this subject).

Fannie’s business is actually a simple one. It provides guaranty operations by stamping its brand and guarantee on bundles of mortgages refashioned into bonds, then earns a spread on the difference between the cost of its liabilities (US treasury equivalent bonds) and the yield on its assets (mortgages). Without its public entity status and government guarantee, how would they be able to stamp its brand and get the US treasury equivalent rating from its bonds? More importantly, without government support, how would they be able to borrow at super low rates equivalent to US treasury so that they can earn a decent spread? Not even the largest investment bank or commercial bank such as JP Morgan in this country can do either one of above. It is actually a more than Skull & Bones type of privilege.

Even it doesn’t conduct transaction directly with government (who does these days? Even foreign central banks are doing most of their transactions in open markets), the guaranty nature from US government for all its debt indirectly transfers the ownership to the government. It is as simple as if you fully guarantee all of your brother’s loans from various banks, it is the same as you implicitly borrow from the banks, your brother’s total liabilities become your liabilities, as simple as that.

Did someone commented “The GSEs couldn't do jumbos or subprime, which are the biggest messes of all.” Really? Where did you get that from? In reality, Fannie’s book has $51.2B of subprime exposure and $344.6B of Alt-A exposure. In addition, Fannie holds $25.8B of private-label Alt-A securities and $25.2B of subprime residential mortgage-backed securities (RMBS) on its balance sheet. The Alt-A RMBS are carried at 85 cents on the dollar and the subprime at 83 cents. Doesn’t sound even close to me, especially the 83 cents for subprime, maybe 25 cents is more likely.

Regarding the Skull & Bones comments, during the S&L crisis, who had protected the Lincoln S&L? The Keating Five, very few but caused public great losses. This time, who has protected the F/F to avoid stronger regulations throughout the years? The few laid out in Paul Gigot’s article.

I think this article at FT this week (linked below), by Joseph Stiglitz, 2001 recipient of the Nobel Prize for economics, expressed many similar views as mine in his article (and he may not want to spend his time to argue with you like me here). For example: the F/F private/public partnerships, in which the private sector takes the profits and the public sector bears the risk. Does that line sound familiar to you? He also said, “Taxpayers should not be asked to pony up a penny while shareholders are being protected.” I might also add “no a penny while F/F bondholders are being protected.”

I totally agree with Dr. Stiglitz, During liquidation of F/F, taxpayers should get the highest priority, fully compensated, then the F/F bondholders, then the perferrs, common shareholders being the last.

www.ft.com/cms/s/0/c69...

2008 Aug 01 10:58 AM

[kdo:]

No, FNM has guaranteed $8B of subprime, of which any LTV over 80% requires collateral enhancements. They own SP as investments, which gives up a gross exposure of $52B, but there is nothing in their charter about not being able to hold securities. That is a different thing, since the egg that's being protected that the govt is scared about is the ability to hold the guarantees. So you're right. $8 billion is not a zero number, so out of a book of $2.7 Trillion of guarantees, that comes out that FNM guaranteed about .296% of it's book of business in SP. Throw in the wraps of private labels which I'll guess required enhancements and we can double that figure. .6% of their total book of business. The sluts.

I'm not defending F/F. *If* F/F go to liquidation, then all securities holdders should be wiped out so that taxpayers have the last liability. I absolutely agree with that and if you were to really pay attention, no one here has commented that they don't think taxpayers will not pay a dime. That is only your interpretation. The problem is you state things as if they've already happened combined with a lack of understanding of how F/F operate and who funds them (private money). Taxpayers have no rights over F/F liquidation since they have yet to provide a dime to F/F. If we end up guaranteeing the loans I think it should be nationalized, because that actually wipes out shareholders and allows taxpayers to make their money back from any potential liabilities they will incur. Putting taxpayers on the hook while equity holders remain intact is ridiculous. It's the facts that are the problem in this article.

btw - I am no expert on F/F, but I don't believe there is anywhere pointing to the fact that their SP exposure is held in CDOs or securities tranched up by risk. If they're simple pass-throughs, using the MER amount they sold their CDOs for is not a remotely realistic measure. The loans *ARE* collateralized, unlike some of the tranches of the CDO, which are collateralized by tranche.

The reality is, if you look at the quality of the loan guarantees in their book, it's dramatically better than what what most banks and mortgage brokers were selling.

86% was long-term, intermediate term fixed.
90% primary residence.

IMO, the problem with F/F is their capital requirements didn't prepare for the 100 year flood, even though it was very apparent that flood was coming. That's what happens if you're overreliant on statistics instead of combining that with common sense. There's quite a number of institutions out there which suffer the same flaw.

2008 Aug 01 02:58 PM

[Fish Gone Bad:]

Wow, there is a lot of heat here. Time to get out the marshmallows, Hershey bars and graham crackers.

On Aug. 11, David Einhorn's company Greenlight Capital RE reports earnings. Perhaps we will hear some words of wisdom from the man who destroyed the "Alpha Female" of Wall Street, and ground Lehman into the dirt.

The special anti-shorting privilege will disappear at 11:59 p.m. EDT on Aug. 12, and will not be extended. If anyone needs to see which companies these are with pork chops tied around their necks, here they are:
BNP Paribas BNPQF or BNPQY, Bank of America Corporation BAC, Barclays PLC BCS, Citigroup Inc. C, Credit Suisse Group CS, Daiwa Securities Group Inc. DSECY, Deutsche Bank Group AG DB, Allianz SE AZ, Goldman, Sachs Group Inc GS, Royal Bank ADS RBS, HSBC Holdings PLC ADS HBC, J. P. Morgan Chase & Co. JPM, Lehman Brothers Holdings Inc. LEH, Merrill Lynch & Co., Inc. MER, Mizuho Financial Group, Inc. MFG, Morgan Stanley MS, UBS AG UBS, Freddie Mac FRE, and Fannie Mae FNM.

All this will happen during congress's August recess.

If any of these banks are as seriously screwed up as Merrill Lynch, you might want to load up on SKF.

Clark Jenkins
FishGoneBad.com

2008 Aug 03 02:24 AM

[TylerJay:]

Wrong!!! People don't get this... Fannie/Freddie did NOT take extra money from taxpayers, and there's a good chance they won't need too... This is just to show explicit support, so other countries will purchase their securities so they CAN get money... If they get the backing, they won't need the cash most likely...

If the whole market keeps tanking, then they might need this - but if we are at or near a bottom - then F/F will be okay from here...

People all over are assuming that they spent this money already - they haven't and probably won't need this...

2008 Aug 04 05:25 PM