“Bloomberg – Too Big to Fix: Fannie and Freddie Are Still a Mess”
I never pass up an article about mortgage markets, so once I saw Bloomberg offering their opinion on why Fannie and Freddie are “still a mess” ten years into conservatorship, I was in from the jump.
Outside of the economic and reputational damage it caused, I’m a big fan of the Financial Crisis, even the fact that we call it “The Financial Crisis” – like there never was or never will be another one. I’m a big finance guy and even bigger policy wonk, so the storylines that emerged out of that period are right up my alley. Most have played out in full and been relegated to the dustbin of history, becoming more folklore nowadays than relevant discussions. There is one that remains, though: the re-privatization of Fannie Mae and Freddie Mac.
Fannie and Freddie are known as Government-sponsored Enterprises (GSEs). They’re private companies that were basically granted monopoly status by the U.S. government in order to keep the mortgage markets functioning smoothly and encourage home ownership. They each have lines of credit with the Treasury Department, are exempt from state and local taxes and, despite being publicly-traded, they’re not regulated by the SEC. Their business models consist of buying private label mortgages, securitizing them and then guaranteeing the mortgages to ensure that interest and principal payments are made on the subsequent mortgage bonds.
The two companies got into a whole heap of trouble in 2008 when the subprime market began to implode and those guarantees became problematic. Long story short: the feds stepped in and the two companies were taken over by the government. In return for the bail out, the Treasury received $1B in preferred stock with a 10% coupon from each entity, as well as warrants for 79.9% of each of their the common stock.
The idea at the time was to bail these two private companies out, stabilize the mortgage markets and then return them back to shareholders at a profit for the taxpayers a la the AIG bailout. However, ten years into the bailout and the government is not one step closer to figuring out what the future will look like for the companies. The problem is two-fold here and, surprisingly, has nothing to do with partisan politics. The first issue is that the two entities are so massive, so integral to the U.S. economy, that any sweeping changes would require years of heavy lifting and, with the stakes so high, nobody has tried in earnest to restructure the companies and return them to private investors. The second issue is that well, the current structure is… working? We’re ten years into this relationship and so far, so good. The mortgage markets are running as smoothly as ever, Fannie and Freddie have returned to profitability and the Treasury is clipping a 10% coupon on its preferred interests. Not to mention, the Treasury mandated that any profit Fannie or Freddie generate be remitted to taxpayers in the form of dividend distributions as well. If you need a summary: the bail out worked and the taxpayers are making a killing. Status quo is always good for governments and this situation is no different – if it ain’t broke, don’t fix it.
Unsurprisingly, not everyone feels that way. Some big name funds like Paulson & Co. and Fairholme have taken large stakes in the companies’ remaining public equity and have preached, quite loudly, that the companies should be returned to private investors and that they’d be able to were the Treasury not siphoning their profits each quarter. On the other hand, you have some politicians that believe the mortgage markets should be a private capital game or that the current situation is an unsustainable band-aid fix.
To these parties I ask: why? For what reason is the current situation unsustainable? Why is it imperative that Fannie and Freddie regain their status as private companies? Forget the fact that Fannie and Freddie were never truly private – any company with tax exempt status and a revolver with the Treasury is far from private. The fact is that homeowners are able to take out reasonably priced mortgages from private companies, bond investors are getting their low risk yield and the taxpayers are making money. The system works! “But it’s a band-aid fix! It was never meant to be this way!” True, very true. You know what else is true though? Every day the government doesn’t do anything to amend the current structure is a day the band-aid fix becomes a little more permanent. Slowly and slowly, as new and old elected officials move in and out of Washington, each Congress becomes a little more detached from the whole thing and will elect to do nothing – as long as everything is functioning as it should.
If you take a step back and actually look at how the system is working now, it seems like this is how it was always supposed to be. Private companies are investing in the mortgage market, consumers are buying homes, taxpayers are generating a profit and the government has a policy tool in Fannie and Freddie. Don’t get me wrong, that was not by design. It was a happy accident that the feds stepped in for a decade and have been successfully running the largest financial services companies on the planet. Let’s not screw this up.