If the public was unaware of Fannie Mae and Freddie Mac, they have received a quick education in the past few days. Unfortunately, the education that they are receiving can be summed up by the hypnotic mantra that has been repeated ad nauseam by politicians and financial commentators alike: Fannie Mae and Freddie Mac are too big to fail.
These comments by Mark Zandi, chief economist at Moody’s Economy.com, are fairly typical:
If the government hadn’t moved and Fannie and Freddie failed, the cost to taxpayers and the overall economy would be enormous. If Fannie and Freddie were unable to play their huge roles in financing new mortgages, the housing market would only suffer more, not to mention the turmoil for the financial institutions around the world that invest in Fannie and Freddie’s debt securities.
Zandi’s comments are exactly the opposite of the truth—if the government continues to bailout those who made bad bets on the housing market, the cost to the taxpayers and economy will be catastrophic, not just enormous.
Fannie Mae and Freddie Mac have engaged in fraud, have helped to corrupt the political process, and have helped to raise the price of housing. Their debt holders should not be made immune from the same sharp decline in the value of their securities that their shareholders have already suffered.
First, the fraud and corruption issue: In May 2006, the Office of Federal Housing Enterprise Oversight (OFHEO), released a “Report of the Special Examination of Fannie Mae.” The report covered the years from 1998-2004 and found that top management at Fannie Mae were engaging in fraud: “By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders.”
Fannie Mae is a prolific giver of campaign money to candidates of both political parties. Instead of responding to the serious accusations in the OFHEO report, they had the temerity, according to Bryon York, to lobby “Congress to cut OFHEO’s funds unless it got rid of the top official in charge of investigating Fannie Mae.” Further, they continue to spend much money lobbying Congress. In the first quarter of 2008 alone, Fannie Mae and Freddie Mac spent about $3.5 million on lobbying and hired 42 outside firms in this effort.
And how have they pushed up housing prices? Mish Shedlock looked at the mission of Fannie Mae: “We are a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market.” Mish pointed out:
Fannie Mae exists to expand affordable housing. Clearly Fannie Mae has failed its core mission. All government sponsored corporations fail their mission. The very nature of promoting housing makes prices go up, until the final blowoff top which we are now on the backside of, having reached Peak Credit.
And who is really being protected? London’s Financial Times reported that “Bill Gross, whose Pimco Total Return fund is the world’s largest bond mutual fund, has tripled his bet on mortgage debt, which now comprises about 61 percent of the fund’s assets. ” Gross commented, “Government policy is moving to sanctify the status of the government-sponsored agencies. It became a question of which institutions would be sheltered by the government umbrella.”
In other words, the taxpayer is bailing out the investors in Gross’s bond fund and others who bought securities issued by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are in trouble because they helped finance too many low quality mortgages; and in so doing, they pushed housing prices up to unsustainable levels. Matt Kibbe, president of FreedomWorks, commented, “The prospectus for every GSE (Government Sponsored Enterprise) bond clearly states that it is not backed by the United States government. That’s why investors holding agency bonds already receive a significant risk premium over Treasuries.”
Thus as Harry Long points out: “Any bailout of the GSEs would not be about homeowners. It would be about charity to financial institutions and investors who have not behaved logically and stand to lose terribly due to sloppy decision making. I like to call it affirmative action for the rich and stupid.“ Bill Gross makes more in a year than most taxpayers will make in a lifetime—it is hardly in the interest of taxpayers that they subsidize him.
There are a few politicians in Congress who understand all of this. Just yesterday, during Senate testimony by Ben Bernanke, Senator and Hall of Fame pitcher, Jim Bunning said,
The Fed is asking for more power. But the Fed has proven they cannot be trusted with the power they have. They get it wrong, do not use it, or stretch it further than it was ever supposed to go. As I said a moment ago, their monetary policy is a leading cause of the mess we are in…
Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed.
The Fed is not the only institution getting bigger bats—Fannie Mae and Freddie Mac are too, and they are destructive bullies. Giving the bullies bigger weapons will only ensure that the once great American economy will continue to be destroyed.