Tuesday, July 22, 2008

What needs to be done about Fannie Mae and Freddie Mac?

There has been a lot of hand-wringing lately about the financial health of the so-called housing GSEs, Fannie Mae and Freddie Mac and the supposed "threat" they allegedly pose to the U.S. economy, but I do believe that most of the criticism and anxiety and anger is either misplaced or ingenuous. A lot of "players" on Wall Street are shorting the stock of Fannie, Freddie, and banks and financial companies in general, so a lot of their complaints are really more in the line of "talking their book" (promoting the stories that serve to benefit their own trading positions) to incite others to put further downwards pressure on the stocks of these companies.

Even before the current (quickly becoming past) housing "bubble", quite a number of Wall Street firms were opposed to the housing GSEs since Wall Street wanted a cut of the action and managed to con Congress into putting constraints on Fannie and Freddie back in the 2003 timeframe, just before the housing "bubble" really started to expand. Fannie and Freddie, by definition, have only dealt in "conforming" mortgages, which by definition are not subprime. Fannie and Freddie are not in any way responsible for the subprime mortgage crisis and do not have any significant exposure to subprime mortgages and related foreclosures.

It is in fact those Wall Street firms that lobbied for shackling Fannie and Freddie over five years ago, and it is those same Wall Street firms that over-inflated the housing bubble with a misguided focus on non-conforming (subprime) mortgages, since they yield (or, rather, once yielded) much higher fees for the Wall Street firms. In fact, one aspect of the scandal is that firms conned consumers into accepting higher-fee subprime mortgages even though those consumers could have afforded cheaper, safer conforming mortgages that Fannie and Freddie dealt in. Wall Street did not directly mislead consumers on mortgages, but they put such an extreme premium on high-risk, high-fee subprime mortgages that they became irresistible to average mortgage sales personnel. Wall Street indirectly enabled this fraud, and the resulting debacle. Wall Street is clearly to blame for the whole subprime mortgage "crisis", but not one iota of blame can be laid at the feet and Fannie and Freddie.

The "crisis" for Fannie and Freddie is simply: 1) too many people are predicting a much higher level of foreclosures of conforming mortgages than is reasonably likely, and 2) too many Wall Street firms have been actively and maliciously attacking the stock of Fannie and Freddie, making it more difficult and more expensive for them to raise capital. The situation has gotten so out of hand on Wall Street that the SEC has proposed special short-sale rules to try to deal with rampant abuse such as naked short-selling, which is already illegal, but nobody on Wall Street has the moral values to prevent it.

The combined market cap of Fannie and Freddie is now only about $19 billion. The U.S. Treasury should simply start to silently buy up the stock, effectively putting a floor on the price as well as a ceiling for buying the two GSEs should the remaining shareholders continue to lose faith and dump their shares. That would probably be the best $20 billion ever spent or invested by the U.S. government and likely achieve a spectacular rate of return, even if the rate of housing foreclosures were to rise significantly further.

Even if it were to cost $25 billion to "rescue" Fannie and Freddie (literally from the short-sellers on Wall Street and their attacks on the stock), which is one estimate I saw today, that is mere peanuts or "chump change" compared to the amount of capital that the Federal Reserve has put at risk to rescue Wall Street itself, to date. For Wall Street to "blame" Fannie and Freddie for the current "crisis" is the height of hypocrisy.

Fannie and Freddie truly are two of the strongest pillars of the U.S. financial system, second only to the U.S. Treasury and the Federal Reserve System. Even the so-called "best" firms on Wall Street are a very distant third-place. Fannie and Freddie have done nothing wrong, save that they became a target for an unscrupulous Wall Street.

At this point, I think that the Treasury should simply loan Fannie and Freddie as much cash as they need to siliently buy back their own stock from all willing sellers. If their stocks stabilize and rise significantly, that process can cease, otherwise the process should continue until the GSEs are fully privatized. Wall Street does not deserve to have these two financial companies be at the mercy of shameless short-sellers. Who knows, maybe the next generation on Wall Street will have some sense of moral decency and maybe in another five years Fannie and Freddie can once more become publically-traded companies.

In my book, Fannie and Freddie are the true angels, fighting on the side of good and economic and financial justice, while Wall Street is now nothing more than thieves without honor. Actually, even that pejorative does not convey enough negativity about the dishonorable behavior of Wall Street.

If you hear anybody saying anything negative about Fannie and Freddie, almost certainly one of three things are true: 1) they are lying, 2) they simply have not done their homework, or 3) they oppose the concept of the GSEs and are simply using the "crisis" as an excuse to promote their opinion. A lot of people actually do not know much at all about the housing GSEs and should do some homework, but so many people on Wall Street could not care less about what the truth really is.

In short, technically nothing needs to be done to "fix" Fannie and Freddie that they cannot do themselves, if only major Wall Street firms were not attacking the stocks of the companies. But given the current situation, the U.S. Treasury should loan the GSEs the cash to either simply boost their stock price or to fully privatize the companies.

-- Jack Krupansky

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