September 14, 2015

The Façade Of Convenience

Yahoo Finance provides this weekend topic based on the following: “Bethany McLean is a contributing editor at Vanity Fair and bestselling author. This excerpt is from her new book, ‘Shaky Ground: The Strange Saga of the U.S. Mortgage Giants,’ published by Columbia Global Reports. ‘Housing was at the root of the global financial crisis in 2008, and seven years on, the mortgage market is still a huge unsolved economic issue. Fannie Mae and Freddie Mac, the government-sponsored enterprises that support American homeownership, were placed on a kind of government life support at the onset of the meltdown. Their ‘conservatorship’ was meant to be temporary, but the government still hasn’t figured out how to resolve their limbo.’”

“‘At one point, Fannie and Freddie had a combined $5.3 trillion in outstanding debt. They’ve become profitable again and have paid $231 billion back to the U.S. Treasury. But their profits are going toward reducing the federal deficit, leaving them undercapitalized. This despite the critical purpose they serve of guaranteeing most Americans’ mortgages. And as explained in the excerpt below, the two companies now also face lawsuits from big investors over the way the government is handling them. This is an investigation into why the country’s mortgage finance system is – again – in a dangerous and unsustainable situation.’”

“On a bitterly cold gray day in December 2014, there was a strangely large crowd at the United States Courthouse in Des Moines, Iowa, where Senior District Judge Robert Pratt was hearing arguments in Continental Western Insurance Company v. FHFA. The title gave few hints as to why the room, the goings-on of which rarely transcend local interest, would be packed close to standing-room-only, filled with representatives of the country’s top investment firms, including a slew of New York hedge fund types, along with prominent Washington lawyers, including a George W. Bush-appointed former U.S. Attorney and a Department of Justice lawyer.”

“The government lawyers were sputtering with outrage about the nerve of the investors to bring a lawsuit at all. It’s not just that investors are accusing the United States government of misdeeds, which in and of itself is obviously a pretty big deal. But on the surface, the lawsuits seem to fail to appreciate the stunning amount of money—$187 billion, or about six times the annual budget of the National Institutes of Health—that taxpayers have put into the rescue of Fannie and Freddie. And taxpayers still could have to contribute more.”

“Said the FHFA’s lawyer, ‘Your honor, even with that $187 billion already infused, at this very moment, Treasury . . . is on the hook to infuse another—if it is required—in excess of another $250 billion of taxpayer dollars, a quarter trillion dollars . . . all this federal money was put in and [the investors] want to avail themselves of that federal money.’”

“To understand why they did it, you have to understand the façade of convenience involved in the 2008 bailout, as well as its unique and punitive terms. When the government put Fannie and Freddie into conservatorship, it got the right to take 79.9 percent of the common stock of both companies. Why not just nationalize them and take 100 percent? ‘If the U.S. government were to own more than 80 percent of either enterprise, there was a sizable risk that the enterprises would be forced to consolidate onto the government’s balance sheet,’ explained housing analyst Laurie Goodman in a report.”

“In other words, the government certainly could have wiped out investors, thereby preventing the problem it has today. But if Fannie and Freddie were nationalized, the federal government’s debt would have skyrocketed. Because any money the government put in would become so-called ’senior preferred stock,’ which would have to be paid before anyone else got anything, it looked like the existing preferred stock and common shares would be worthless. But they still traded on the New York Stock Exchange, albeit for pennies.”

“Because the dividend payment further reduced their net worth, they also had to draw additional money from Treasury to fill the hole caused by the dividend payment. According to a FHFA official, around $45 billion of Fannie and Freddie’s $187 billion bailout consisted of draws that took money from Treasury only to round-trip it right back to Treasury as a dividend payment. (Other analysts think the figure is lower, around $30 billion.) ‘It was a complete payday lender situation,’ says someone close to the situation. ‘It was like borrowing from a loan shark.’”

“One of the first people to call it publicly was an Australian hedge fund manager named John Hempton. In an August 2009 blog post, he noted that the actual cash losses Fannie and Freddie had reported to date were ’simply not large enough to have caused problems.’ After going through filings, he noted that the estimates of future losses were ‘extremely harsh.’ Hempton would later call Fannie and Freddie’s post-bailout financial report the greatest accounting fraud he’d ever seen. He didn’t mean fraud in the usual sense of fraud, in which a company understates its losses, thereby making the financial picture look prettier. He thought Fannie and Freddie were overstating their losses, thereby making the financial picture look uglier.”

“In one way, the investors were right. Fannie and Freddie have indeed produced immense profits—in total, they have paid $239 billion to the government over the last three years. But they were very wrong in another respect. We are now past the 7 year anniversary of the conservatorship, and the financial crisis, and the rhetoric has not changed. The government still says it wants to kill Fannie and Freddie.”

“In a recent note, Bank of America Merrill Lynch analyst Ralph Axel wrote this: ‘The fate of government-sponsored enterprises (GSEs) is not only of critical interest to home buyers, home builders and mortgage bankers but also to almost every investor class across the globe. For a market that thrives on being considered a substitute for Treasury debt, turbulence and uncertainty is the worst case scenario. But unfortunately, the fate of the GSEs is still very much in flux, and more so today, in our view, than ever before.’ The housing market—and as a result, the financial system—remains on shaky ground.”

Bits Bucket for September 14, 2015

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