MONEY CULTURE
Daniel Gross
Fannie, Freddie, Folly
Why the two mortgage giants can't be allowed to fail.
Fannie Mae and Freddie Mac, the two government-sponsored enterprises that play an important role in the mortgage market, are tanking today and helped briefly drag the Dow Jones Industrial Average to below 11,000 for the first time in two years. Investors are concerned that the companies, after racking up big losses (with much more red ink to come), might have difficulty raising needed capital from investors. Between them they have on their books or stand behind about $5 trillion in mortgages, including plenty of junk. As Charles Duhigg reported earlier this year in The New York Times, "By the end of last year, the companies had guaranteed or invested in $717 billion of subprime and Alt-A loans, up from almost none in 2000."
While the Senate today pushed through a foreclosure rescue plan, there have also been reports that the Bush administration is considering plans to place the two companies into receivership. Should Fannie and Freddie fail, there's no question that executives and policymakers should blame themselves for poor decisions made over the last several years. But Fannie and Freddie's current travails can also be ascribed to the more recent screw-ups of the big investment banks.
The troubles of the private-investment sector will make it much harder to rescue Fannie and Freddie. For much of the past year, the CEOs of the nation's iconic financial firms have reported unexpected losses, declared their troubles over and raised money from investors (frequently foreign ones) to make up for those losses, only to report fresh losses a few months later. Lehman Brothers CEO Richard Fuld on April 15 boldly proclaimed, "the worst is behind us." In the three months since then, Lehman reported further losses and its stock has lost half its value. Last year, we noted the challenges facing investors and institutions that tried to catch falling knives in the financial sector. Last September, Joseph Lewis, one of Britain's wealthiest men, spent $860 million on a 7 percent stake in Bear Stearns, paying an average of about $107 per share, according to The Wall Street Journal. Bear was sold to JPMorgan Chase in March for $10 per share. As saviors were quickly turned into chumps, outside investors began demanding better terms--i.e., buying stocklike securities that paid interest rates, or buying shares at a discount to the market price. But even these savvy investors have been burned. Last November, to take one example, Citigroup sold interest-bearing convertible securities to the Abu Dhabi Investment Authority that convert into Citi shares at prices ranging from $31.83 to $37.24 per share between 2010 and 2011. Since then, Citigroup's stock has fallen by more than half to less than $17. Sovereign wealth funds that bought into offerings from companies like Merrill Lynch have suffered the same fate.
When asked to comment on such deals, Treasury Secretary Henry Paulson would always try to make lemonade out of the lemons, noting that these dilutive capital raisings are a sign of great faith by foreigners in America. Now, however, institutional investors are likely to think twice about putting billions of dollars to work in U.S. financial firms, and especially into Fannie Mae and Freddie Mac. The concern--and skepticism--over the ability of the two firms to raise fresh capital on anything resembling decent terms is part of what's behind the abrupt fall in their stocks. As of yesterday's close, Fannie Mae had a market capitalization of about $13 billion and Freddie Mac was worth about $5 billion. Given the massive size of their portfolios, and the potential for losses, it's clear they will need to raise sums that may equal or dwarf their current market capitalizations. Given their distressed state, buyers would certainly demand a discount.
As JPMorgan Chase CEO Jamie Dimon's now-famous formulation about Bear Stearns has it, "'Buying a house is not the same as buying a house on fire." Fannie Mae and Freddie Mac are houses on fire. And this mentality leads to a vicious cycle: investors jump ship because they fear dilution, and the more the stock slips, the more dilutive capital-raising becomes. As I write, Fannie Mae's market capitalization has shrunk to about $10 billion. In addition, potential foreign investors would face thorny political issues. If Americans are upset that a Belgian company wants to buy Anheuser-Busch, just imagine the uproar if a Persian Gulf emirate took a huge position in Fannie Mae, and hence stood to benefit from an implicit taxpayer subsidy.
Treasury Secretary Henry Paulson today tried to scupper talk of a bailout. "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission." Should Washington intervene and explicitly do what has been implicitly assumed all along--backing Fannie Mae and Freddie Mac's debt--critics on the left will correctly claim that it's another example of privatizing profit and socializing risk. Critics on the right will argue that the government has effectively nationalized the mortgage industry.
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Member Comments
Posted By: Nowforthetruth @ 10/15/2008 1:44:51 PM
Comment: Bill Clinton points to liberal Congressional Democrats' protection of Fannie and Freddie from scrutiny as a primary cause of the current economic meltdown.
http://www.youtube.com/watch?v=XsynspIqAoE
To prove Bill Clinton's point, this is a link to a C-SPAN video clip of the Congressional hearings at roughly the time McCains attempt at S.190. to fix fannie and freddie.
http://www.youtube.com/watch?v=_MGT_cSi7Rs
"Video Unearthed Democrats in their own words Covering up the Fannie Mae, Freddie Mac Scam that caused our Economic Crisis"
The link below describes how some of those Democrats in Congress tried to use the original version of the bailout bill to divert money eventually recovered to groups like ACORN. See: Wall Street Journal
http://online.wsj.com/article/SB122247015469280723.html?mod=googlenews_wsj
And here is Lou Dobbs reporting on ACORN corruption and ties to Obama, including Obama Campaign paying ACORN $800,000 for voter registration activities, and Obama representing them when he was a practicing attorney.
http://www.cnn.com/video/#/video/bestoftv/2008/10/09/ldt.tucker.acorn.under.fire.cnn
Posted By: DiamondJim @ 07/13/2008 10:11:36 AM
Comment: Posted By: cutter37 @ 07/12/2008 7:54:01 PM
Comment: If the Gov't. had never gotten into the social engineering business (promoting and pushing for everyone to own a home, many of whom should be apartment dwellers-not the end of the world you know) we might well of not had this "subprime" (read: poor risk) fiasco. Now the imbeciles in Congress conduct hearings to deflect blame from their own incompetence.
I can't believe you so grossly misunderstand the "sub prime" lease fraud.
"Sub Prime" mortgages existed not because of social engineering (some call it the "American Dream" and the maintenace of a healthy middle class that is the basis of our democracy) but due to greed, fraud and lack of adequate regulation. This is a product of a centerpiece of neo-conservatism, i.e., "DEREGULATION".
This mess will now be dumped on the American people, not just in the loss of the "American dream" but by the assumed bailout og Ginnie May and Freddie Mac, adding ane estimated $5 trillion dollars to the national debt, which embarassingly was brought about during the 20 + year tenure of Republican "fiscal conservatives".
Your "knee jerk" "blame the government"response shows that you have been properly brainwashed bt the "neo-cons"
The "imbiciles in Congress were led by largely neo-con extremists.
You are shooting youself in the foot.
The answer is not so east as "blame the government" "That's just scapegoating".
Posted By: Nins @ 07/13/2008 1:29:22 AM
Comment: Know why McCain wants to distance himself from former Senator Phil Gramm? It's not because of Gramm's obnoxious remarks calling Americans "a nation of whiners" who are in "a mental recession." Those remarks were so ascerbic that they may've been made just to give McCain an excuse to distance himself from Gramm. This issue is a lot deeper than it looks on the surface.
When Gramm was a Senator he was Chairman of the Banking Committee. He pushed through the legislation known as the "Enron Loophole." This loophole allowed US investment banks to bypass Federal regulations governing futures trading, and is the reason why investment banks were able to falsely inflate the prices of oil, wheat, corn and other commodities through massive futures trading, causing your costs of gas, heating oil and food to go through the roof.
Gramm also created the Gramm-Leach-Biley Act, which got rid of the laws that seperate banking, insurance and brokerage activities in America. The Gramm Act was touted as a new way to protect consumer privacy, but the real meat on the Act's bones was banking deregulation. Essentially, this Act did away with laws written after the Great Depression to protect us from another Wall Street/Banking Industry collapse. That's right, Gramm stripped the system of it's safe guards nine years ago, and guess what? The value of the dollar has nose-dived, four major economic institutions have failed, Wall Street is unstable, and we are in a worsening recession.
Notably, the US investment banks that gained the most from the Enron Loophole and from the Gramm Act contributed more than a million dollars to Gramm's campaign.
Currently Gramm is Vice Chairman of UBS, the Swiss Bank that came up with the idea of "death bonds." Worse, though, UBS is involved in a scam where they sold auction rate securities to American customers. Auction rate securities are supposed to be as safe as cash, but the way UBS did it, the fees garnished by their in-house investment bankers were intentionally higher than the return on the securities, ripping off their American customers. The Massachusetts Attorney General has already filed charges against UBS, and private brokers world-wide have dropped UBS stock. UBS is forecasted to lose 82.91% of it's value in 2008. We are talking about the corporate bank where Gramm is Vice Chairman. Looking at his track record there and at the havoc he has wrought on the US economy through the Senate Banking Committee, it's clear that Gramm is a either criminal or grossly incompetent.
Now McCain wants nothing to do with Gramm, wants us to forget Gramm has been a key player on McCain's team. Gramm was McCain's campaign CO-CHAIR and LEADING ECONOMIC ADVISOR. Previously, McCain had said that he planned to appoint Gramm as SECRETARY OF THE TREASURY.
With Gramm as McCain's leading economic advisor, now you know why economists and analysts say that McCain's economic policy plans are untenable.