New York Times Death Spiral Watch (Adam Nagourney and Megan Thee Edition)

FNMA: A History Lesson

John M. Berry: Fannie, Freddie Have Worn Out Their Independence:

July 16 (Bloomberg) -- It's time to put an end to the charade that no one ever believed. Fannie Mae and Freddie Mac would be dead without the announced backing of the federal government for the securities they issue to guarantee home mortgages. That's a strong argument for dropping these public-private partnerships, in which management and shareholders have taken the public for a ride. Treasury Secretary Henry Paulson's plan to shore up the companies includes no direct protection for stockholders, and their share prices plunged more yesterday. Fannie Mae closed at $7.07, down 82 percent this year, while Freddie Mac fell to $5.26, off 85 percent for the year....

The two companies own or guarantee more than half the $12 trillion of home mortgages in the U.S., so there was never any reason to think the government wouldn't step in to keep them operating.... However, instead of just finding ways to keep them going, Paulson should have proposed a government takeover -- with a payment to shareholders based on, say, July 11 share prices of $10.25 for Fannie and $7.75 for Freddie.

Over the years, both Fannie and Freddie have made very large profits precisely because they were able to raise money by selling securities regarded by most investors as carrying a government guarantee. As we have seen this week, the investors were right.... [T]he implicit subsidy has been enormous.... [CBO] estimated that in 2003 the annual value of the subsidy to the housing government-sponsored enterprises -- these GSEs include Fannie, Freddie and the Federal Home Loan Banks -- at $23 billion. Only about half that got passed on to homeowners in the form of lower interest rates on mortgages, the CBO said.... Fannie and Freddie persuaded members of Congress to let them issue ever-more debt.... Federal Reserve Chairman Alan Greenspan expressed concern about Fannie and Freddie in congressional testimony in February 2004 because... they had not chosen to manage risk by holding more capital....

[T]hat is the source of today's crisis for Fannie and Freddie: Investors believe the companies have large unrecognized losses.... As much as anything, the crisis represents a political failure. Congress wasn't willing to see the two companies reined in. So it's time to end the public-private partnership with its built-in conflict of interest.... Let's make them fully public entities whose role is to support the securitization of home mortgages...

The privatization--such as it was--of the FNMA was accomplished in 1968, I believe for three reasons:

  1. Getting FNMA debt off the federal government's books allowed Johnson to postpone moving a bill raising the limit on the allowable national debt through congress.
  2. Providing mortgage insurance seemed to the then-Budget Bureau to be much closer to an "insurance" function that was properly private than a "central banking" systemic risk-control function taht was proprly public.
  3. Nobody in 1968 imagined how good FNMA would turn out to be on Capitol Hill in using congressional power to draw the teeth from regulation, and how effective FNMA would be in persuading Wall Street that it had much more of a government guarantee than your standard large financial institution.

Truth be told, I am having a hard time understanding why FNMA and FHLMC equity has dropped so much. The power to borrow money at essentially the Treasury rate and use it to make mortgages is awesomely valuable. FNMA and FHLMC shareholders own that power--unless the Fed and the Treasury force it into a Bear Stearns- or LTCM-like fire sale. That is, I think, what the market fears.