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Fannie Mae and Freddie Mac are back in the news, in large measure for the crime of being too profitable and raising a very uncomfortable question: When will shareholders get back their companies?
The two government-sponsored enterprises (GSEs) were seized by the federal government in 2008 at the height of the financial panic. At a time when many large financial institutions needed federal bailouts this did not seem unusual to most observers, however Fannie Mae and Freddie Mac were not banks, financial service companies or even auto companies. Instead, they were in the business of creating a “secondary-market” for mortgages, an electronic “place” where home mortgages that met certain standards could be bought and sold.
The existence of a secondary market has become crucial to the American housing market. It works this way: The First Local Bank of Wherever has enough capital to fund mortgages worth $50 million. It loans out all the money and once that happens it’s unable to create any additional mortgages because it has no more money to lend. The solution: First Local sells its mortgages on the secondary market, gets new capital and can now continue to finance local loans. The result is that local lenders are able to originate additional loans and interest rates are held down because of the widespread availability of capital.
Where do Fannie Mae and Freddie Mac get the money to buy local mortgages? That comes from massive investors in the U.S. and overseas from such sources as pension funds, insurance companies, sovereign funds and rich individuals.
Financial Strength
The government spent $1.7 trillion for bailouts but did it need to rescue Fannie Mae and Freddie Mac?
In July 2008, a few weeks before Fannie Mae and Freddie Mac were seized, the government reported that the companies had $1.5 trillion in unpledged assets. In effect, their reserves were so huge that the possibility of Fannie Mae and Freddie Mac failing was just about zero.
Unlike banks and auto companies, the Federal government did not merely write a check and bail out the GSEs. Instead, both companies were seized by the government with a “conservatorship,” an arrangement which gives the government control of the GSEs and continues at this time.
The conservatorship has been very lucrative. The government loaned $117.1 billion to Freddie Mac and so far has gotten back $136.4 billion. The story with Freddie Mac is much the same: $71.3 borrowed from the federal government and $91.8 returned. That’s a total of $188.4 paid out and $228.2 paid back, a profit of $39.8 billion.
It’s hard to ignore nearly $40 billion and the GSE income may be addictive for Uncle Sam. In addition, the current situation with Fannie Mae and Freddie Mac raises several other issues: First, there’s been an effort on Capitol Hill to replace Fannie Mae and Freddie Mac with new players. Second, when the government seized the two companies it paid nothing to the shareholders — a huge Constitutional no-no because the Fifth Amendment’s “taking clause” says the government must provide “just compensation” when grabbing private property. Third, the government plainly wants the GSE money flow to continue but a looming court suit may make that impossible.
New Players
A number of plans have been offered which would dump Fannie Mae and Freddie Mac and replace them with new entities, usually on the grounds of increasing opportunities for “private capital,” meaning big banks and Wall Street firms. In these proposals, however, the federal government would ultimately guarantee or insure the mortgages purchased by the new firms, meaning a situation exactly the same as the one now in place with Fannie Mae and Freddie Mac.
Why so much interest in replacing Fannie Mae and Freddie Mac? Profits.
It’s estimated that a switch to private-sector firms would increase mortgage costs by 1 percent. That may not seem like a lot but in the context of trillions of dollars in annual transactions it adds up. Of course, the higher costs would have to be paid by someone and that “someone” would be mortgage borrowers. Steeper mortgage costs would have other results as well such as fewer real estate transactions and reduced state transfer tax collections.
Government Liability
The federal government’s Fannie Mae and Freddie Mac ownership may be less certain than many people think.
When the government took over the GSEs it did so with a “conservatorship” and not a “receivership.” With a receivership investors lose everything because the receiver takes possession of the assets. With a conservatorship, according to the Federal Housing Finance Agency, “a person or entity is appointed to establish control and oversight of a company to put it in a sound and solvent condition.” In other words, a conservator does not take possession of the assets.
This distinction is a very big deal — especially for Fannie Mae and Freddie Mac shareholders. In 2013 the government announced a “Sweep Amendment,” which said that once all loans had been repaid it would simply keep all future GSE profits. This is a problem for two reasons: First, shareholders are not getting the money. Second, Fannie Mae and Freddie Mac cannot use retained earnings to grow because there are none — all the cash is going into federal coffers.
“If the government wanted to assume the powers of receivership,” said attorney Ted Olsen, “it could have chosen that course. Instead it chose conservatorship, and with the Sweep Amendment it overreached, exceeding the legal boundaries of the statute and failing to meet obligations of conservatorship.”
If the name “Ted Olsen” seems familiar it might be because he was the Solicitor General under President George W. Bush; the winning counsel in Bush v. Gore, the case which gave the 2000 presidential election to Bush; and — more recently — the winning co-counsel who argued Hollingsworth v. Perry, the 2013 Supreme Court case which overturned the same-sex marriage ban in California.
With Olsen the challenge to the federal conservancy — and to billions of dollars in new GSE revenue the government hoped to collect — is entirely credible. It closely follows the 1996 Winstar case, a Supreme Court decision which resulted in the payment of $30 billion in claims by savings-and-loan investors following government seizures.
The Illusion of Revenues
Politicians can say the deficit is smaller and no, we didn’t “raise” taxes, by collecting GSE money. The excess money paid by Fannie Mae and Freddie Mac — almost $40 billion so far — is enough to finance the entire fiscal 2014 cost of the Department of Housing and Urban Development.
With the lack of capital for reinvestment ordained by the Sweep Amendment, it’s very possible that GSE income will fall this year and that could encourage the government to raise G-fees, the charges exacted by Fannie Mae and Freddie Mac for their services. Those charges grew from .22 percent in 2009 to .51 percent in 2013 under the conservatorship.
What happens if G-fees increase? Mortgage borrowing becomes more expensive and that’s not good for either borrowers or home sales.
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