It’s alive!: Rebuilding the Fannie-Freddie Frankenstein
The U.S. Treasury Department reportedly is wrestling with a plan for the recapitalization and reprivatization of Fannie Mae and Freddie Mac, two behemoths at the center of the $10 trillion U.S. mortgage bond market.
As a former mortgage bond salesman, I suffer painful flashbacks from Fannie Mae and Freddie Mac. Their weird past, and current status, represent one of the last unresolved issues of the 2008 mortgage crisis.
Since their $187.5 billion bailout — and effective nationalization — in September 2008, virtually all profits from Fannie and Freddie have been remitted to the U.S. Treasury. Fannie and Freddie’s first-quarter 2019 profits were $2.8 billion and $2.2 billion, respectively, and all of it went to the federal government. Over the last 11 years, they have returned more in profit to the Treasury than they received in the bailout.
The Obama administration inherited the problem of these companies from the Bush administration in 2009. But it couldn’t figure out a way to move forward on a permanent resolution of their status.
The Trump administration is close to announcing its plan for Fannie and Freddie. Let’s hope it’s not investors’ favorite option, the “recap and release plan” — meaning raise enough private capital to make the companies fail-proof and then turn them back into private entities.
If they truly become private, well then, fine. But I have my doubts. My worry is they will revert back to the publicprivate hybrid monstrosities they were before the 2008 crisis. Bloomberg reported that Treasury Secretary Steve Mnuchin would like the privatized companies to retain a government guarantee. Ugh. That’s the part I don’t like.
What I don’t like are companies that straddle the line between public and private. What I really don’t like — and here’s what Fannie and Freddie always represent to me — is the hybrid-company problem, which is best summarized as “privatize the gains, socialize the losses.” By existing in their in-between status as “government-sponsored entities,” Fannie and Freddie were the ultimate “heads I win, tails you lose” companies.
In the 2000s, bond buyers loved owning Fannie and Freddie debt, known as “agency debt,” because of this in-between status. They were private, for-profit companies, sure, with private shares trading on the New York Stock Exchange. But they had the implicit backing of the federal government because they had been originally chartered by Congress and because they played such a systemically important role in the mortgage bond market. So they could issue more debt, at cheaper rates of interest, than any fully private company.
The federal government tried to claim, numerous times, that it didn’t fully backstop Fannie and Freddie agency bonds. They were “government-sponsored,” not “government-guaranteed.” But, of course, in the end the government did guarantee the debt. It was a distinction without a difference.
Government-guaranteed, but paid like the private sector! Totally malleable to government political pressure! Borrow at below-market rates to grow your balance sheet without limit. What’s not to love? Good times!
In the end, Fannie and Freddie didn’t cause the crisis. They were kindling in the firestorm of housing-based overindebtedness. After investors and executives collected the profits, the taxpayers were left with the liabilities.
Let’s hope Mnuchin’s Treasury Department comes up with a better plan for the future.
Michael Taylor is a columnist for the San Antonio Express-News and author of “The Financial Rules For New College Graduates.” michael@michaelthesmart money.com | twitter.com/michael_taylor