The Fannie and Freddie Fallout

July 13, 2008
Fair Game
The Fannie and Freddie Fallout
By GRETCHEN MORGENSON

IT’S dispiriting indeed to watch the United States financial system, supposedly the envy of the world, being taken to its knees. But that’s the show we’re watching, brought to you by somnambulant regulators, greedy bank executives and incompetent corporate directors.

This wasn’t the way the “ownership society” was supposed to work. Investors weren’t supposed to watch their financial stocks plummet more than 70 percent in less than a year. And taxpayers weren’t supposed to be left holding defaulted mortgages and abandoned homes while executives who presided over balance sheet implosions walked away with millions.

Over the course of this 18-month financial crisis, we have lurched from land mine to land mine. Last week’s was all about Fannie Mae and Freddie Mac, the giant government-sponsored enterprises set up to provide affordable housing across the nation. By issuing debt, these shareholder-owned companies guarantee or own more than $5 trillion in home mortgages. Got that? $5 trillion.

Because the federal government established the companies, investors view them as backed, at least implicitly, by taxpayers. And that implied guarantee is what drove Fannie and Freddie’s business models.

The advantages the companies gained from this unique arrangement were huge. They had to keep less cash on hand than traditional lenders, for example. They also made more money on their mortgages than lenders because they paid less to borrow money in the bond market. These profits enriched Fannie and Freddie shareholders over the years and bestowed significant wealth on the companies’ executives.

Now it looks as if the bill for that largess is coming due. Of course, it will be borne by the usual bagholders: United States taxpayers. You and me.
For years, anyone warning that Fannie and Freddie should beef up their financial positions was ridiculed or run over by the lobbying machines these companies kept oiled and close at hand. So their lucrative arrangement remained the same: business as usual, with all its riches, was the goal. After all, wasting money by inflating their cash cushions would just crimp their style.
Suddenly, Fannie and Freddie’s relatively anemic capital supply is a concern. Last week, Fannie’s stock plummeted to $10.25, down 74 percent in 2008. Freddie’s shares also dived, closing at $7.75, a loss of 77 percent this year.
Even as investors were stampeding out of these stocks, the claque in Washington rushed to reassure them. Both Ben S. Bernanke, the Federal Reserve Board chairman, and Henry M. Paulson Jr., the Treasury secretary, said the mortgage giants’ regulators confirmed that the companies were “adequately capitalized.”

THAT was supposed to signal that the companies wouldn’t have to raise capital immediately because regulators had the problem firmly in hand. But investors have good reason to be skeptical. In the first half of 2007, both Mr. Bernanke and Mr. Paulson sang a similar tune when they opined that problems in the mortgage market were “contained” to subprime loans.

Talk of adequate capital also brings to mind comments made last March, when Bear Stearns was on the ropes, by Christopher Cox, the chairman of the Securities and Exchange Commission. He tried to calm investors by telling them that Bear Stearns passed financial muster. Days later, the firm was toe-tagged.

Which brings us to the main problem: credibility. Wall Street and our senior regulators seem to be running out of that precious commodity almost as quickly as cash.

It wasn’t as if this problem came out of left field. Fears that Fannie and Freddie were getting too big have been a recurring theme in recent years. And Congress has had ample opportunity to create a new regulator that would be vigilant about ensuring the safety and soundness of both companies.

But even after both companies were found to have accounted for their results improperly, Freddie Mac in 2003 and Fannie Mae in 2004, Congress failed to act. As a result, Fannie and Freddie were allowed to become high-growth companies and stock market darlings.

“These companies would have been fine had they been forced to be the cyclical utilities they were intended to be,” said Josh Rosner, an analyst at Graham-Fisher, an independent research firm in New York. “They would be healthy and able to help the markets in this time of illiquidity.”
Instead, they are in trouble and their woes are infecting the entire stock market.

The surprise is not that Fannie and Freddie grew too large for the taxpayers’ good. That was to be expected among companies run by executives whose pay is based on profit growth.

Rather it is that Congress and the various financial regulators, especially the Fed and the Office of Federal Housing Enterprise Oversight, did little to keep the companies from getting out of control.

MAYBE the loans held or backed by Fannie and Freddie will turn out to be better performers than those held by other lenders. That would mean fewer losses than investors seem to be anticipating now and would still the cries for fresh capital.

But if their losses follow the patterns seen at other lenders, some sort of regulatory takeover may occur. That would mean a lot of pain for a lot of folks — especially both companies’ stockholders and the broader community of people depending on a secure, smoothly functioning mortgage market.
“The real outrage is that none of this had to happen,” said William A. Fleckenstein, co-author of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve” and president of Fleckenstein Capital in Issaquah, Wash. “We did not have to ruin the financial system and ruin the financial lives of a huge chunk of the middle class in the United States.”

“It is crystal clear that the Fed not only made mistakes, they had the pompoms out, cheering for deregulation,” he adds. “Until people recognize why we are in this mess, I don’t see how we get out of this thing.”
A week ago, Bridgewater Associates, a research firm, estimated that losses from the credit crisis we’re now mired in might amount to $1.6 trillion when all is said and done.

We’ll have to wait years to see if this is accurate. But whatever the number is, it will also represent, in stunning red ink, the cost to society of financiers who are shortsighted and greedy and regulators who don’t regulate.

Barr:  Fannie Mae/Freddie Mac Bail-out Unfair to Taxpayers
Tuesday , July 15, 2008

This is a rush transcript from "Your World with Neil Cavuto," July 14, 2008. This copy may not be in its final form and may be updated.

CONNELL MCSHANE, GUEST HOST: My next guest says the move today is not good news for taxpayers.

Libertarian presidential nominee Bob Barr is with us.

Welcome to you, sir.
• Video: Watch the 'Your World' interview

Now, why is this a bailout, first of all? Because as Brenda was going through details there, basically, what the Treasury said, what the Fed said is not that they would bail these companies out, but they would be there to help if something went wrong, not that they're going to do something now.

BOB BARR, LIBERTARIAN PRESIDENTIAL CANDIDATE: Well, of course, the Treasury has no money of its own. It's all taxpayer money. That's something that seems to get lost frequently in these discussions, where you have the government stepping in and saying, well, we're going to do this or we're going to that, and it's not a bailout because we're providing a backup or sort of a psychological blanket or a temporary line of credit.

But the bottom line is, this is all taxpayer dollars that we're talking about here. And, whenever taxpayer dollars are used or committed, even impliedly, the taxpayers of this country are being put at further risk.

MCSHANE: The question you have to ask yourself, as you know, in these situations is, what happens if I do nothing? What would happen if the Treasury, the Fed, the government did nothing in this case?

BARR: I think right now, doing nothing would not be advisable. As much as a Libertarian, we don't like to see — and I don't like to see — the government get further involved with yet another sector of the economy.

I think, because the government has caused this problem, similar to the savings and loan problem that the government caused a generation ago, it has to do something.

The question is, can it do enough by providing some temporary security, some temporary backup?

MCSHANE: Right.

BARR: Yet, as long as it is done with the thought in mind that there has to be long-term congressional action here to restructure and reformulate the very way Freddie Mac and Fannie Mae operate, I think that would be an advisable solution, but not doing nothing.

MCSHANE: All right, so which part of it do you have a problem with, if any? Is it the part where they come in and say, all right, we might buy stock in these companies, the government buying equity in publicly traded companies? Is that where you have a problem?

BARR: I have a problem with that because that will simply lead to further government manipulation — which is always, by definition, artificial — of that sector of the marketplace, in this place — in this case, housing.

I think, though, that, if we — we have some — some temporary line of credit — and I think it's important to do this through the Congress, so Congress understands and has a stake in this as well.

MCSHANE: Right.

BARR: But the ultimate goal, I think, has to be a very firm commitment to restructure Fannie Mae and Freddie Mac.

MCSHANE: Quick political question while we have you on, sir. I know you're running for president under the Libertarian line. The last poll we have — and we're showing it on the screen there — shows you with 3 percent support.
Why are you in the race?

BARR: Well, that's an old poll. The most — the more recent one by Zogby has — has us at 6 percent nationally, and actually in double digits in some states. That is a very strong base of support to begin a campaign as a third-party nominee. So, I think there is a tremendous opportunity there.

And these sorts of problems that have been manifested themselves by the work over the years of the Democrat and the Republican parties alike provides just that opportunity.

MCSHANE: Right.

All right. Former Congressman Bob Barr of Georgia, Libertarian presidential nominee, we appreciate your time. Thanks a lot for coming on with us.
BARR: Thank you, Connell.
MCSHANE: All right.

 Jim Rogers attacks Fannie Mae and Freddie Mac bail-out

By James Quinn, Wall Street Correspondent
Last Updated: 1:09am BST 18/07/2008

Renowned currency trader Jim Rogers has blasted the US government's planned bail-out of Fannie Mae and Freddie Mac as an "unmitigated disaster".
His former trading partner, hedge fund guru George Soros, warned that the banks would not be the last victims in the "most serious financial crisis of our lifetime".

News of the bail-out sent the shares of the two banks up as much as 20pc in early trading, but the gains were quickly eroded as investors feared the possibility of another collapse in the regional banking sector.

The Dow Jones Industrial Average was down 97 points at one stage and, by lunchtime on Wall Street, Fannie Mae was down 55 cents at $9.70, while Freddie Mac was off 84 cents at $6.91.

The price falls came despite strong demand for a $3bn debt sale by Freddie Mac, the first test of the company's borrowing ability since last week's dramatic share price falls.

Reaction to the Treasury and the Federal Reserve's bail-out plan was mixed but Mr Rogers was the most vocal. He argued that Fannie and Freddie, America's largest mortgage finance companies which own or guarantee some $5 trillion of mortgage debt, are "basically insolvent".

He said: "I don't know where these guys get the audacity to take out money, taxpayer money, and buy stock in Fannie Mae." He added that the US government should instead have allowed Fannie and Freddie to go bankrupt.
Mr Soros said the dollar remained vulnerable as a result of the government's actions to increase its own already sizeable debt pile.

Investors pointed to regional bank National City as the next possible victim as its shares fell 27pc in early trading, despite assurances from the Ohio-based bank.

It followed the Federal Deposit Insurance Corporation's seizure of California's IndyMac Bank on Friday, the second largest failure of a US bank. IndyMac reopened yesterday under FDIC control, with borrowers queuing to withdraw cash at many of its 33 branches .

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