“All this makes clear why Fannie and Freddie cannot be privatized and returned to the markets in the form they were before their 2008 insolvency. The fiction that Fannie and Freddie weren’t government-guaranteed has now been exposed…

…The markets now know for sure that if the two fail again they will be rescued by the government. If there is any honesty in budgetary accounting, their borrowings will have to be treated as government debt and added to the deficit. It is unlikely that the Trump administration or Secretary Mnuchin will be happy to add several trillion dollars in debt to the already bloated U.S. debt load. On the other hand, Fannie and Freddie clearly cannot act profitably as secondary mortgage-market players—buying mortgages from banks and others—unless they have a lower cost of funds than the mortgages they will buy. That might be possible with the capital levels that support a triple-A rating, but even the Johnson administration realized that this wouldn’t work. Capital levels that high probably cannot be achieved or sustained without promising investors levels of profitability that are unavailable to mortgage-market participants.Thus, there is only one alternative if Fannie and Freddie are to be “privatized” and still expected to act as secondary market players. As truly private firms, without triple-A ratings, they will able to securitize mortgages through the structured transactions that many banks and others used before the mortgage meltdown in 2008. This is a viable and important business, and needs to be restored, but its capital requirements are modest and there will be many competitors. Most certainly, they won’t have the financial advantages that allowed them to dominate the housing finance market before 2008. Nor will they earn the profits that are exciting the speculators who—on the strength of Mr. Mnuchin’s statement—have been bidding up their shares.”, an excerpt from Peter J. Wallison’s, “A Fannie Mae and Freddie Mac Background Check”, The Wall Street Journal, December 2, 2016

“Think about it…..the federal government structured Fannie Mae and Freddie Mac as private entities, with an implicit government guarantee….so they could fool the American people that the debts we actually guarantee do not include Fannie and Freddie’s trillions, yet allow these entities debts to trade at rates almost identical to U.S. Treasury securities…..isn’t that the leading off-balance sheet “fraud” in the country? Remember many claiming that legitimate private securitization activities of banks and others….approved by accounting standards, lawyers, government regulators, and the market….was a “fraudulent” activity designed to under-report liabilities? The government’s pre-crisis structure of Fannie and Freddie was no different and magnitudes larger. Mr. Wallison, is “spot on” versus The New York Times Gretchen Morgenson, who wrote a similar article this past Sunday and failed to address the fact that Fannie Mae and Freddie Mac’s profits are derived almost solely from its federal government/taxpayer guarantee. In other words, privatizing them roughly as before, would change nothing (the stricter lending standards and higher guarantee fees of today, would erode over time, as they have done in the past under political and special interest pressure) and result in the privatization of profits and the socialization of losses. Let’s never forget that these two entities required almost $190 billion in funds to recapitalize themselves and even with those funds, would have never been able to repay those funds, but for the government (taxpayers) standing behind their unsecured debt and mortgage securities in conservatorship.”, Mike Perry, former Chairman and CEO, IndyMac Bank

A Fannie Mae and Freddie Mac Background Check

Reports of privatizing the government-sponsored mortgage-finance giants are greatly exaggerated.

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Fannie Mae headquarters in Washington, D.C. PHOTO: BLOOMBERG NEWS

By Peter J. Wallison

President-elect Trump’s nominee for Treasury secretary, Steven Mnuchin, said on Wednesday that Fannie Mae and Freddie Mac should be “privatized.” This comment sent their share prices soaring, as investors speculated that the two firms will be allowed to recapitalize and return to the mortgage markets as the dominant players they once were.

This outcome is highly unlikely, as a little history shows, and that’s why Mr. Mnuchin’s comment was probably misinterpreted by investors.

As originally conceived during the New Deal, Fannie Mae was a government agency that would borrow funds in the credit markets and buy mortgages from banks and other originators. The idea was that this would provide a secondary market for mortgages, giving lenders the cash to make more loans.

As a government agency, however, Fannie Mae was on-budget and its expenditures added to the deficit during the Vietnam War.

In 1968, accordingly, Fannie Mae was given a congressional charter as a corporation and allowed to sell shares to the public. This permitted the Johnson administration to argue successfully that Fannie should be excluded from the budget. But it also raised questions about whether Fannie could operate profitably without government backing.

As a buyer of mortgages, Fannie could only be profitable if its cost of funds was substantially lower than the mortgages themselves.

The Johnson administration tried to solve this problem by giving Fannie sufficient connections to the government so that, even as a private shareholder-owned firm, it would still be treated by the credit markets as though it was government-backed.

Thus Fannie was blessed with many special connections to the government, including a line of credit at the Treasury, a government “mission” and the appointment of some of its directors by the president. This signaled the markets that it was still implicitly government supported without the explicit guarantee that would put it back on the budget.

The idea worked. The market believed—despite legislative language that stated otherwise—that the government would in fact stand behind Fannie. And when Freddie Mac was given an identical government charter in 1970, creditors were willing to lend to both firms at rates that were close to the Treasury’s own favorable rate. Indeed, they were called “the agencies” by the market, which signaled something government-like.

All this makes clear why Fannie and Freddie cannot be privatized and returned to the markets in the form they were before their 2008 insolvency. The fiction that Fannie and Freddie weren’t government-guaranteed has now been exposed. The markets now know for sure that if the two fail again they will be rescued by the government. If there is any honesty in budgetary accounting, their borrowings will have to be treated as government debt and added to the deficit.

It is unlikely that the Trump administration or Secretary Mnuchin will be happy to add several trillion dollars in debt to the already bloated U.S. debt load. On the other hand, Fannie and Freddie clearly cannot act profitably as secondary mortgage-market players—buying mortgages from banks and others—unless they have a lower cost of funds than the mortgages they will buy.

That might be possible with the capital levels that support a triple-A rating, but even the Johnson administration realized that this wouldn’t work. Capital levels that high probably cannot be achieved or sustained without promising investors levels of profitability that are unavailable to mortgage-market participants.

Thus, there is only one alternative if Fannie and Freddie are to be “privatized” and still expected to act as secondary market players. As truly private firms, without triple-A ratings, they will able to securitize mortgages through the structured transactions that many banks and others used before the mortgage meltdown in 2008. This is a viable and important business, and needs to be restored, but its capital requirements are modest and there will be many competitors.

Most certainly, they won’t have the financial advantages that allowed them to dominate the housing finance market before 2008. Nor will they earn the profits that are exciting the speculators who—on the strength of Mr. Mnuchin’s statement—have been bidding up their shares.

Mr. Wallison, a senior fellow at the American Enterprise Institute, is the author of “Hidden In Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again” (Encounter Books, 2015).

Posted on December 6, 2016, in Postings. Bookmark the permalink. Leave a comment.

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