Rethinking Fannie, Freddie and Mortgages

For what it is worth, I am the proud owner of a “Fannie Fraud Patrol” T-shirt.  The fraud patrol was a loose mix of investors who felt that Fannie Mae’s (FNM) finances were misstated back in 2003.  My small contribution to the effort was showing that the fair value balance sheet was not compatible with the standard balance sheet.  That was a pretty basic finding for an actuary used to doing cash flow testing.

I did not post much on Fannie and Freddie after the partial takeover by the US Government last week, because there wasn’t all that much that I could add.  I had gotten my calls right, most notably:

• A Way to Make Money Off of Fannie and Freddie, and
• Buy Agency Mortgage Bonds

If you followed those calls, you made good money, particularly the first one.

But with all of the fuss over the actions of the Treasury, I must note several items:

• Congress has the power to reverse or modify what the Treasury has done.  (Not that I ever expect much out of Congress…)
• Even if the Treasury succeeds in lowering mortgage rates, that does not mean much when borrowers aren’t capable of scraping together the proper down payment.   Lower interest rates do not stimulate economic sectors under stress, but do stimulate healthy sectors, as housing did in 2001-3, while industry suffered.
• I don’t like being a wet blanket, but aside from preventing systemic risk from letting senior debt and agency MBS suffer credit risk (these are big things), there isn’t a lot to boast about in the takeover.  At best, this leads to the wind-off of two entities that never should have been created.  Housing should not be subsidized by US taxpayers.

To the free market purists, who I sympathize with, I say let the hybrids die.  Our government has meddled too much in lending markets, but it is egregious when they do so where there is a private profit motive.  This bailout delivered real pain to those that were equity holders, while protecting against systemic risk.  The moral hazard issue to equity and preferred holders is dead.  They can lose it all, or close to it.  This is real improvement.

To liberals I say the public interest has been protected.  Systemic risk is avoided.  It is better that those without the wherewithal to own homes rent, than that they strain to own.

To all of Congress I say, if the Administration comes to you asking for a rise in the debt ceiling, ask them to sell their mortgage-backed securities first.  Why should those with mortgages be favored over renters and freeholders?

Comments

[xsuddensam:]

The government should not be intervening to avoid "systemic risk " The market needs to wash out all the players who created this mess in the first place. Saving a flawed financial system, which inevitably will fail, is madness. It's time to take the hit, pay the piper and rebuild.

We need to rid ourselves of the Greenspans, Bernankes and Paulsons. We need to restore sanity to our monetary and banking systems by throwing out the Federal Reserve and by reasonably regulating the banks.

Most importantly, perpetrators of financial fraud should be harshly punished by asset confiscations and long prison terms. There should be laws passed for crimes against the public interest. There is no excuse to give these criminals a pass or a slap on the wrist when they are harming millions and millions of people.

It may be painful, but we are a resiliant people who have often risen in the face of adversity and we have triumphed.

2008 Sep 13 09:28 AM

[icandoitdon:]

the federal reserve has done far more harm to the financial system than good. those who claim that the fed "saved" the system, have it exactly backwards. the federal reserve's primary mandate is to preserve the stability of the financial system and they utterly failed in that task. they lit the fire that caused the house to burn down and they get no credit from me by coming in with the fire hose now.

cheap credit and debt supports this entire country....it's citizens and it's government. the "cure" these bastards are using for this doomed model of overleverage...more cheap credit, more borrowing, taxpayer bailouts and printing of money.... is a disgrace.

2008 Sep 13 11:04 AM

[TinyMIghty:]

I agree with xsuddensam. All the government regulatory agencies need to look into any white collar criminals who created all the mess and put them in jail. The U.S. government did not protect everyday people from the crooks stealing money systemically through insurance, mortgage, and charity organizations. It is a time for all the regulatory agencies to clean out the house of thieves so that they do not repeat this same stupid mistakes again.

2008 Sep 13 11:08 AM

[dannyp52:]

"To the free market purists, who I sympathize with, I say let the hybrids die. Our government has meddled too much in lending markets, but it is egregious when they do so where there is a private profit motive. " -- a voice of sanity and reason, finally!

2008 Sep 13 11:37 AM

[outtafavr:]

This is an excellent article. The author is a very brave man. In discussing the reason for Fannie/Freddie's existence, he refers to housing being subsidized by taxpayers. There's more to it than that. The GSEs were used to manufacture a hot economy. So many jobs were created in the process of building and selling all those houses. This was all done with cheap money borrowed by the government in disguise as GSEs, blazing a $10 trillion path to nowhere. For 70 years everyone was fooled. The giant "DEAD END" sign is now visible to many, including David Merkel.

Allowing the GSEs to fail would cause immense pain to the economy and our financial system. Short term pain would turn into long term gain and result in a much more rapid return to prosperity and overall financial health. This society could never be courageous enough to cause any pain for itself. The GSEs, the government, and the economy, all being one in the same, are destined to die a very slow agonizing death.

2008 Sep 13 12:00 PM

[henarl:]

Amen to xsuddensam & TinyMighty. The individual executives who perpetrated this mess should be jailed and fined at least an amount equal to what they have profited during their last few years of mismanagement. Unfortunately, this will never happen as the people who run our government agencies that have the power to do that are part of the same good old boy network as the above mentioned executives and will always help their buddies. ie; Paulson, Bernanke, Donaldson, etc.

2008 Sep 13 02:16 PM

[carey_jim:]

First, there is no free market in food production, water distribution, secondary education, fire and police protection, automobiles (except for used cars,) military services, postal services, illegal drugs, prostitution, choice of the number and gender of spouses, pharmaceuticals, medical education, dental education (as there is in legal education where a bar exam determines whether one is a lawyer or not and not being accepted by a government approved medical or dental school), radio and television licensing and rents, to mention only some notorious areas of government involvement in commerce.

Free markets are not always the best solution of every problem of the distribution of goods and services (often, of course, they ARE,) so it is not a foregone conclusion that the government should not regulate the buying and selling of homes as it does so many other important things in life.

Note that I am not saying the government SHOULD regulate the housing industry only that that the government DOES regulate so many other industries that it is not helpful to sing the national anthem of free enterprise over the (possible) recent demise of the free market mortgage industry.

During the 19th century, the American economy was built on tariffs or government interference in free markets, as most of you will remember from your economic history classes. During the 20th century the Korean and Japanese economies were built the same way.

Just saying ....

2008 Sep 13 02:59 PM

[woodsey:]

When we discuss what needs to be done we need to keep in mind that the very body who will be doing it is the US Congress, the author of much of the hell. Caution is the order of the day.
I am a somewhat dense "old guy", but I "get" the article and agree.

2008 Sep 13 03:19 PM

[Kinabalu:]

"My small contribution to the effort was showing that the fair value balance sheet was not compatible with the standard balance sheet"

As I look at the FRE & FNM June 30 balance sheets it is striking how much better FNMs financial condition looks than FRE. If I were a FNM shareholder I would be irate, and screaming at my Congressman, about the takeover at a time the company had a 4.7% capital ratio and a primary regulator that said 1 month ago that the company's need for a capital infusion was overstated.

Was this a case of the Treasury Secretary just reacting to the foreign sovereign wealth funds demands for an explicit guaranty and beating up on the regulator to get an insolvency verdict?

2008 Sep 13 04:07 PM

[Martin19:]

So these fnm and fre stocks that people have will b wiped out with no value or will they recover in years

2008 Sep 13 07:44 PM

[msgtb:]

The Freddie and Fannie MBS bonds clearly state that they are not guaranteed by the U.S. Government. The taxpayers have been ripped off again. The bankers need to go to jail not be bailed out.

2008 Sep 14 01:44 AM