Foreclosure Home News and Opinion Fannie Mae, Freddie Mac Not Over the Cliff

Mortgages: The Fiscal Cliff Is Not The Only Fake Crisis

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Much of the past month has been spent arguing about the fiscal cliff and the economic woes which might instantly ensue in 2013 without some sort of saving legislation. But while the fiscal cliff is an artificial crisis, it's not the only one – just look at mortgages and the ongoing efforts to either shrink Fannie Mae and Freddie Mac  or make them go away altogether.

Political thinkers and great minds kept telling us that the fiscal cliff should have been settled months ago and that the whole matter was really a big financial dare, not something any logical person would undertake.

“The specter of harmful across-the-board cuts to defense and nondefense programs was intended to drive both sides to compromise,” says the Office of Management and Budget, “The sequestration itself was never intended to be implemented."

If this seems somehow familiar you're right; we've had artificial financial “emergencies” in the past.

For instance, in the 1980s the government took over large numbers of savings-and-loan associations, businesses that were driven into the appearance of non-profitability by suddenly-changed capital requirements. The Supreme Court ultimately ruled in the Winstar case that shareholders had been bilked and the federal government was responsible for some $30 billion in claims – at a time when $30 billion was real money.

Now history is repeating itself with Fannie Mae and Freddie Mac.

The Crisis That Wasn't

In September 2008 Fannie Mae and Freddie Mac were seized by the federal government. A “conservator” was put in place to run the two “government-sponsored entities” (GSEs) that had managed to rack up large profits for shareholders, big bonuses for executives and huge risks for taxpayers.

The speed of this take-over was breath-taking, but a careful look at the process shows several problems.

First, the two organizations had losses – but they were not broke. They had assets of $1.5 trillion, enough to fend off any conceivable claims. They also had tremendous leverage in the marketplace (an 80-percent market share), ongoing revenues and had never shut down or failed to make payments. There was no need to nationalize them. They could have paid off claims and settled with their creditors in any event. Meanwhile, GM, AIG and a number of major banks could just as easily been taken over by the government, but magically that was not the case.

Second, when Fannie Mae and Freddie Mac were nationalized their share values plummeted. As it happens, community banks – under federal regulations – were encouraged to own preferred stock in the GSEs as part of their capital base. When the companies were federalized small lenders lost $16 billion in capital – losses many could never re-capture. The result was hundreds of small bank failures and increased market share for big lenders.

Tilting The Marketplace

Today lawmakers are standing by, ready to mandate solutions. For instance, the Residential Mortgage Market Privatization and Standardization Act of 2011 would make Fannie Mae and Freddie Mac smaller “by forcing the institutions to guarantee the credit on a decreasing percentage of the mortgage-backed securities they issue.”

Then there is the proposed Housing Finance Reform Act. It would create privately-owned housing finance guaranty associations backed with guarantees provided by taxpayers. Of course, there's no rule which prevents private organizations from competing against Fannie Mae and Freddie Mac without government assistance.

Making Fannie Mae and Freddie Mac smaller does not mean the marketplace to buy, sell and guarantee mortgage-backed securities would contract or that foreclosures and short sales would go away. It only means that Fannie Mae and Freddie Mac would be less able to compete and that the big banks that would own the new competitors would get bigger.

Less competition, of course, suggests a few problems.

"While this route would not add liabilities to the government balance sheet, the transition to a private mortgage finance market would involve a massive shift in resources and infrastructure from GSEs and other government institutions to private enterprise," said Smith Breeden Associates, a specialist in mortgage-backed securities (MBS). "This would certainly raise mortgage rates in the short- to-intermediate term, and likely jeopardize the current housing recovery, which could potentially derail the overall economic recovery."

As MBS securities expert William A. Frey says in Way Too Big To Fail, competitive limits would increase loan costs by roughly 1 percent. While 1 percent may not seem like a big deal, it surely is when you consider the immense size of the secondary market or the difference between financing at 3.5 percent and 4.5 percent.

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How absurd it was for the government to put Fannie and Freddie (FnF) into conservatorship. No bailout was ever needed. FnF had plenty of cash flow to weather the storm. The treasury required FnF to borrow from the treasury through the issuance of senior preferred shares $1 billion dollars each just to be put into conservatorship. Then they required FnF to "borrow" more taxpayers dollars when ever their assets values dipped below their liabilities - or when they were technically insolvent. Several big companies are technically insolvent, like Delta Airlines and AutoZone. They pay their bills just fine, and FnF could have too until they got back to profitability. On top of having to get capital from the Treasury that they did not need, they were also required to pay the government a 10% dividend. This required FnF to get even more funds from the government as paying the dividend on occasions caused their assets to dip below their liabilities. FnF have paid over $50 billion in dividends for funds they could have got along without. It gets better though. On August 17th the US government said FnF no longer has to pay the 10% dividend on roughly $190 billion. They now require FnF to hand over all of their profits starting in January. Looking at recent profits that would have the government earning nearly 20% in dividend (interest) charges. Would one ever think that Uncle Sam would turn into a loan shark. The FnF shareholders have also never been given a plan to pay back the principle, nor will they be able if the government confiscates ever dime they back. FnF loan quality has always been better than the FHA's. If the FHA is now just coming to a need to possibly tap the taxpayers, why wasn't it expected that FnF could have done the same with their superior cash flow and lower delinquency rates. The shareholders are being robbed of their company. One can argue that the government should get out of the mortgage business, but the government should still respect the private individual ownership of Fannie and Freddie and allow the shareholders the ability to remove themselves from conservatorship. Conservatorship is to protect value, not to steal it. Posted: January 2, 2013 by: Joe Stocks

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