Fannie and Freddie: Back at it?

Washington is where good ideas go to die. 


Washington may be where “good ideas” go to die, but, like zombies, they come back. Two of the most important institutions in the underpinnings of the financial crisis that fomented the Great Recession were Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). The older sister, Fannie, is a government-sponsored enterprise (GSE). Founded in 1938 during the Great Depression as part of the New Deal, the corporation’s purpose is to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities. This allows lenders to reinvest their assets into more lending and in effect increasing the number of lenders (and debt) in the mortgage market. Freddie Mac was created in 1970 to further expand the secondary market for mortgages and to “securitize” them. Do any of these terms ring a familiar note?

A GSE is a financial services corporation created by Congress. Their intended function is to enhance the flow of credit to “targeted sectors” of the economy and to make those segments of the capital market more efficient and transparent. They are also intended to reduce risk to investors and other suppliers of capital. Well, let’s just say… the best laid plans… Fannie and Freddie never got the credit they deserved for the fiscal disaster.

Fannie Mae grew so large over the years that in 1968, with the pressures of the Vietnam War straining the national budget, President Lyndon Johnson took Fannie Mae’s debt portfolio off the government balance sheet (how convenient). Fannie Mae was converted into a publicly traded company owned by investors. Two years later, Freddie Mac was launched, primarily to keep Fannie Mae from functioning as a monopoly. It went public in 1989.

[Source: This Fannie-Freddie resurrection needs to die, Editorial Board of the Washington Post]

Fannie Mae and Freddie Mac collapsed following the financial meltdown. They were placed in “conservatorship” that has “constrained” them since 2008. You and I, fellow taxpayers, were tasked with nursing them back to profitability with the help of $187 billion in taxpayer funds. Lucky us. At the time these GSEs were placed in “conservatorship” they held more than $5 trillion in mortgage-backed securities. Federal debt at that time was only $9.5 trillion. Wow!

As unlikely as these two bedfellows may be, hedge funds and low-income housing advocates both want the two mortgage-finance giants to return to their pre-financial-crisis status as privately owned but “government-sponsored” enterprises. That is to say, to recreate the private-gain, public-risk conflict that helped sink them in the first place. Of course, their motivations are quite different.

Hedge funds bought shares of Fannie and Freddie for pennies on the dollar when they collapsed. If Fannie and Freddie return to “private” corporations, the hedge funds would realize a massive gain if the government allows shareholders to have access to company profits again. Low-income-housing advocates have made common cause with the hedge funds because Fannie and Freddie represent a potential massive source of funds for their “do-gooder” programs – you remember, making loans to people who have a high probability of defaulting.

Whether you come down on the side of those who believe that government’s fostering of subprime mortgages caused the financial crisis or the greed of “Wall Street” and hedge fund managers caused it, it is clear that letting Fannie and Freddie loose again is a bad idea. Abolishing them would be a better idea in my opinion.

Congress has effectively barred the resurgence of these two GSEs becoming “private” again from happening, at least for the next two years. Even the Obama administration is opposed to their release from “conservatorship.” Nonetheless, rest assured that forces from both the left and the right will not let this sleeping dog lie.

A word to the wise…

Roy Filly




About Roy Filly

Please read my first blog in which I describe myself and my goals.
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