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SEPTEMBER 8, 2008 3:42PM

Fannie Mae, Freddie Mac and the costs of laissez-faire

Rate: 9 Flag

The Federal government took over Fannie Mae and Freddie Mac on Sunday, with the goal of preventing both entities from failing and taking the US and world economies with them. While Paul Krugman is right to describe this as a "de-privatization" rather than "nationalization," the effective difference is very little.

While Andrew Leonard over at "grown-up" Salon points out that Fannie Mae and Freddie Mac are suffering as much as anything because of the deflation of the values of the assets that they are guaranteeing, both organizations plunged into the riskier end of the mortgage and associated securities market in order to respond to Wall Street expectations for growth. The lack of adequate regulation that felled Bear Sterns and has led to enormous write-downs and a credit crunch in the private sector has just taken on a multiplier effect.

The Economist provides a succinct overview of the takeover package here. While the government could theoretically recoup bonds in the future, and has passed the cost of taking on 80% of Fannie Mae and Freddie Mac stock onto shareholders in the form of reduced value and no payment of dividends, the cost of the stock and of loans secured by both organizations' assets could easily hit $100 billion. Just by contrast, the Resolution Trust Corporation ended up spending $124 billion to resolve the fallout from the savings and loan debacle in the early 1990s.

Also remaining to be seen is the cost of bailing out banks such as Gateway Financial Holdings that are over-exposed to Fannie Mae and Freddie Mac stock.

There's a time, and this may be it, for a legitimate debate about whether Fannie Mae and Freddie Mac should have been allowed to have the neither-here-nor-there status of the two organizations as operating in a for-profit fashion without also letting go of the protection of taxpayer backing. These questions should have been asked when both organizations became more risk-acceptant and focused on growth.There are good answers from either a conservative or liberal standpoint about why Fannie Mae and Freddie Mac should have been forced to shit or get off the pot.

But now that the two organizations barely have a pot to piss in, in portfolio value terms, I think it's time that someone, perhaps someone whose name is Barack Obama, should ask why it is that the Republicans think it's a good idea to either deregulate or not adequately regulate financial institutions if they are still going to use taxpayer money to pick up the pieces. It would also be worth pointing out that John McCain was in the thick of deregulation that led to the savings and loan debacle. Taxpayers picked up the tab for that debacle, as noted above, to the tune of $124 billion. When is John McCain going to show his concern for American taxpayers by either regulating properly, or not bailing out the people and organizations which weren't regulated at their request?* Precisely how much taxpayer money will have to be spent for McCain and his ilk to admit that they are wrong?**

(Historical footnote: The S&L settlements included bailing out Neil Bush in Colorado, remember him? He was on the board of Silverado Savings and Loan, which got $1 billion in bailout money for a civil settlement of $26.5 million against the Board of Directors, of which Bush paid $50,000.)

* I'll answer my own question: Approximately never.

** See above.

*** Since we can't have non-Palin post on politics, hopefully the McCain campaign has assigned someone to work up a response who actually knows what they're talking about.

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Boring, but important. (Very, important.)

Corporate welfare abounds.
Thanks, I think.

Actually it drives me up the wall - here's a real cost associated with the Republicans "governance," and does anyone care? No, we're too busy fucking around with pregnant teenagers (so to speak) and moose stew.
It was amusing watching Morning Joe this AM. Freddie and Frannie are front page countrywide, but Mika and her merry band of commentators just didn't want to go there. The whole not something our viewer will understand vibe was palpable.

They visibly relaxed when they could go back to Palin bounce in the polls.
Bleh... Fannie. Too much wine with lunch.
The Keating Five were four Dems and one Rep - McCain. McCain actually had the least involvement.
LT - so you're saying it might not be the best thing to bring up? I suppose that being a POW and the first American to orbit the earth (John Glenn) buy you some leeway ; )
Nope -- actually I think it should be THE topic of the week.

However, this is bi-partisan crime. Most of our elected officials want this to quietly go away. The public fisk takes it in the neck once again and no one is held accountable. Just the way they like it.
Well then all the more reason to bring it up, then. This is not the time to be giving the current administration and the Congress a pass for all being wrong. I know that $100 billion isn't much against an annual budget of $3 trillion, but pretty soon you're starting to talk about real money.
I agree Haggis. "Boring, but important" is something I picked up from that magazine I got free with my last Salon subscription -- The Week.

Didn't mean to offend you with it. It was more of a commentary on how the media is avoiding this as too complicated/boring/etc.
The Fannie and Freddie debacle were a bipartisan effort. One believing in hands off, the other believing everyone should be able to own a home whether they could afford it or not. Now both have to deal wit the fallout.
jimgalt, that's almost fair but not quite. You're right that government targets for low-income borrower mortgages created an opening for Fannie Mae to get into that market, but the evidence is that they did so in largely in response to their interest in portfolio growth and concern that the private sector had outstripped them in the subprime market. They had also been buying securities backed by subprime loans for some time, which is at best an indirect way of backing up the mortgage market.

Whatever side of the aisle one sits on, this behavior should have been cause for concern.

LT, point taken. I took The Week for a while as well, but it was so-right wing that I ended up only reading the last few pages on culture and sport.
VERY important! Not that I have a house. I have debt (student loans and credit cards) and no money, but I know many people who are watching their middle-class portfolios shrink to almost nothing. Meanwhile, we have speculators spiking up food and gas prices to pad their rich portfolios. All this just saddens me. If you can't count it with your own hands, you don't need it.
In speaking of Neil Bush, let's not forget about Andrew McCain:

"Son of presidential nominee John McCain was reportedly former board member; closing marks the 11th bank failure this year"

"Nevada regulators closed Silver State and the Federal Deposit Insurance Corp. was appointed receiver of the bank, based in Henderson, Nev. It had $2 billion in assets and $1.7 billion in deposits as of June 30.

Andrew K. McCain, a son of Republican presidential nominee John McCain, sat on the boards of Silver State Bank and of its parent, Silver State Bancorp, starting in February but resigned in July citing "personal reasons," corporate filings with the Securities and Exchange Commission show. Andrew McCain also was a member of the bank's audit committee, responsible for oversight of the company's accounting.

The younger McCain, who is the chief financial officer of Hensley & Co., the beer distributorship of which Cindy McCain is chairwoman, is the Arizona senator's adopted son from his first marriage."

Oops! Good job getting out before there were any Sarbanes - Oxley issues to deal with.

I wish my father had been a career politician - imagine a happy life filled with influence-peddling and lucrative sinecures!
Well, I hate to open myself up to the wrath of OS, but as someone who owns property and makes a living in the real estate business, I am relieved to see this happen. There is a lot of untangling that needs to happen all throughout the mortgage industry and I'd rather see it start to happen this way than through the infernal crash and burn of Fannie and Freddie.
" It would also be worth pointing out that John McCain was in the thick of deregulation that led to the savings and loan debacle. "

The whole Bush debacle is the result of years of deregulation -- securities, banking, and oh so many more. Opened the door for the thieves to take all with no consequences and no remorse.

I am also in the real estate business and would like to see this problem resolved. Credit has been tight, and although the rates have been relatively low for the past several years, they are currently on the higher end of the lower spectrum.

With all the bargains in foreclosures and preforeclosures, investors and buyers should be snapping up the bargains. Some are and some are not. Overall, the perception in our market seems to be that mortgages are too expensive just now. With overall economic uncertainty, the media is saying NOTHING positive about the housing market. Any significant lowering of mortgage rates in combination with favorable press could tip the balance in favor of a recovery as investors jump in to snap up the undervalued inventory.

There are other issues just now as well. The Florida housing market is effected by decisions within local government as well. Just as we suspected, here in Florida taxes continue to go up in spite of declining housing values. The greed on all levels is mind-boggling. In spite of our best efforts to fight for better legislation, sloppy thinking, loopholes, graft and lack of ethics rule the day in this state (not much has changed since 2000).

All the same, the bailout of Fannie Mae and Freddie Mac must be handled efficiently. Since there is no evidence that this happens within the ranks of the current administration, I am more than a little nervous for the condition of our entire economy. Certainly, the housing market is poised for recovery -- I suspect if not before, then by late spring after we have settled in somewhat to a new administration.
Oh, lalucas, you brought up so many tangents I could go off on. I don't even know where to start. It's really an exhausting time to be in this business.
hipchick and lalucas - I'm actually in favor of this move, inasmuch as it's the best of the likely alternatives. Certainly it's better than just letting everything crash to prove a point.

I am curious about the proposition that housing is poised for a recovery. I have a hard time imagining that positive press and lower mortgage rates would do the trick for the average buyer, because there's been significant inflation in living costs at the same time that housing prices - and the buying power that they provide - has deflated. In other words, if equity is down, and people's relative cashflow is down, why would they sign up for more / new property and more debt?

I assume that doesn't constrain investors who have the capital to buy against the market, but how much of the real estate business do they represent? Purely projecting here, but supposing I had been thinking about a discretionary housing purchase (i.e., not moving for work) I would no more do it at the moment than fly in the air.
Haggismold, I can only speak for the DC area, but here's my take.

I don't think we can only blame lenders and greedy investors for the housing bubble. For several years, DC residents saw, in many cases, 5 and 6 figure appreciation within ridiculously short periods of time. I was writing competing offers on almost every property I wrote on. People were paying cash over appraisal, nixing home inspections, etc. It was insane.

Now, when there is inventory on the market, interest rates are still at historic lows (and now poised to come down due to the Fannie Freddie takeover), and there are incentives from the stimulus package including high conforming FHA financing, and a Federal first time homebuyer credit, doesn't it make a whole hell of a lot more sense for people to buy now?

The media has continued to focus on all the crap (including reports and statistics that are largely irrelevant to local markets) and seems to be pleased to ignore the not-so-exciting positive aspects.

The DC area continues to see a healthy job market and economy. The buyers I tend to meet now have been carefully watching and see the opportunites. They have good jobs and money to put down. They are a bit less risk taking than buyers of past years; often first time buyers. They are getting great deals. They are able to negotiate. They see buying real estate as a long term investment, not as a short term way to make a buck.

When the elections happen, people seem to think that there is a mass exodus during an administration changeover. Sure, some people leave, but a lot of people who hold positions in the current administration will shift over to L Street jobs and new people will come in. Additionally, people continue to move closer in to shorten commutes.

My biggest issue in getting ready, willing, and able buyers into homes right now are the changing loan guidelines.

I've posted a teensy bit about this. I'm afraid to open the floodgates and turn the focus of my little recreational blog into something work-related, but I might have to pull some of these thoughts together more.
Yeah, and this ain't even the scariest part Haggismold. There's another "unregulated" market in this country as well--that's been able to operate for three generations of "suppliers" now with no transparency and oversight. Know much about Hedge Funds?
hipchick - all of those points are well taken, and I think I was backing into something like what you are getting at. You're seeing people with professional salaries buying against the market and the first time buyers with cash in hand are exactly the people I'm not thinking about - I'm thinking more of people who got hammered with loss of equity on those increases that we all enjoyed here (I'm local, for what that's worth). People who bet big on new builds in Germantown with low equity, in other words.

Ben Sen, don't get me started. Remember Long Term Capital Management? A good friend of mine is a mathematician and told me that he had seen an explanation of the models that they used to make their buying decisions. His reaction to about every third technique or assumption was "Ooh, I wouldn't have done that." I can't help but wonder how many more decisions like that drove investment choices that are going to blow up.
The CBO sucker-punched the White House today. It stated that debts stemming from Fannie Mae/Freddie Mac would have to be added as public debt--adding trillions of dollars to the books.

And the financial costs for insuring US-based debt-products have reached a record high on the international market. The costs of protecting U.S. Treasury debt with credit default swaps are now substantially higher than doing the same for debt from other large economies--like Japan and Germany, for example.

Why does that matter? Because it means the market rates the possibility of the US government defaulting on its debt more likely than other large economies from defaulting on theirs.

Not quite a vote of confidence for the US economy.
RCMoya - whee! More debt! Higher interest rates! Damn the torpedoes, full speed ahead!
In 1999 the then president of Fannie Mae took charge of the Smithsonian Institution, effectively becoming the boss of all my bosses. At the time I was an exhibits and lighting specialist at African Art. Aside from trying to push inept changes, ( The galleries are too dark! I want more, more light! Doh - anything above 9 foot candles is destructive to fragile objects and art) he brought his special fraud skills to bear on the SI. At least he's gone from there.

There were so many red flags that were simply ignored.

Europe is all abuzz with excitement over the "nationalization" of the two Fs. Corporations in which the government has a principal ownership are common in many european countries. Germany's Lufthansa comes to mind. My Austrian hubby is amazed that the US public doesn't seem to get what has really happened. Or that it isn't a major recurring headline. No the press chews and chews Palin and hurricanes and this just kinda glides on by......

Haggis, looks like we're neighbors