easy assignment
Nov4, 2019,04:07pm EST|4,175 views
Forbes: The Government Should
Have Shut Down Fannie and
Freddie In 2008 – They Still Can
Norbert Michel Contributor
Policy
I follow the evolution and devolution of monetary and financial policy
WASHINGTON, DC – SEPTEMBER 10: U.S. Treasury Secretary Steven
Mnuchin (L), U.S. Housing and Urban … [+] GETTY IMAGES
https://www.forbes.com/sites/norbertmichel/
https://www.forbes.com/sites/norbertmichel/
https://www.forbes.com/policy
1
Our nation’s housing finance system was at the center of the 2008 financial
crisis. Yet our elected officials have done nothing to fix the problem—until
now. Credit Mark Calabria, the new director of the Federal Housing Finance
Agency (FHFA), for giving it an honest effort.
2
Despite all the hype claiming that the Dodd-Frank Act would fix the financial
system and make everyone safer, Fannie Mae and Freddie Mac are essentially
just as weak today – and just as dangerously leveraged – as they were in 2008.
3
Calabria and his new team at the FHFA can’t be expected to solve this
problem overnight, but it looks like they are on the right path.
4
On the heels of reiterating that the federal government should have wiped
out Fannie and Freddie’s shareholders in 2008, Calabria recently warned
members of the Mortgage Bankers Association that “Today’s status quo poses
significant risk to taxpayers, homeowners, renters, and the entire financial
system.”
5
Last week, the agency released its new Strategic Plan for the
Conservatorships of Fannie Mae And Freddie Mac, emphasizing that the
FHFA wants a competitive mortgage market where nobody – even Fannie and
Freddie – has a set of special rules. That sort of market would be a major
break from the past, but it is now the goal:
https://thehill.com/blogs/pundits-blog/finance/343084-7-years-in-dodd-frank-still-protects-main-street-from-excessive
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
Calabria says he’s willing to wipe out Fannie Mae, Freddie Mac shareholders
Calabria says he’s willing to wipe out Fannie Mae, Freddie Mac shareholders
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan
https://www.aei.org/wp-content/uploads/2019/06/The-Housing-Lobbys-APOR-Solution-is-fatally-flawed-final
https://www.aei.org/wp-content/uploads/2019/06/The-Housing-Lobbys-APOR-Solution-is-fatally-flawed-final
“compared to the duopoly of Fannie Mae and Freddie Mac, moving
toward a more competitive secondary mortgage market – in which the
same rules and regulations apply equally to all – would better serve
borrowers and renters. Competition more effectively delivers
market-affordable prices with customer satisfaction and continual
innovation to improve product quality.”
6
Given that Calabria unabashedly wants to work with Congress to create “a
competitive mortgage market with a limited government role,” Americans
should be optimistic that things are heading in the right direction.
7
Unfortunately, Calabria and his team will face continuous pressure from all
corners of the housing finance lobby to upset the status quo as little as
possible. That pressure, of course, is the main reason that so little has changed
since the 2008 crisis, and that Fannie and Freddie remain so highly leveraged.
8
Many people balk at this suggestion and argue that Fannie and Freddie
remain so highly levered because the U.S. Treasury has been taking all of their
profits, thus preventing the companies from building capital.
9
But this narrative omits crucial context, especially the part about how Fannie
and Freddie would not exist today without hundreds of billions in taxpayer
support.
https://www.forbes.com/sites/steveforbes/2021/02/09/how-covid-19-will-change-public-school-education-forever/
https://www.fhfa.gov/Media/PublicAffairs/Pages/Statement-of-FHFA-Director-Mark-Calabria-on-the-Administrations-Plans-for-Housing-Finance-Reform.aspx
https://www.fhfa.gov/Media/PublicAffairs/Pages/Prepared-Remarks-of-Dr-Mark-A-Calabria-at-MBA-2019-Annual-Convention-and-Expo.aspx
https://www.forbes.com/sites/norbertmichel/2019/01/14/bipartisan-housing-finance-reform-a-blatant-giveaway-to-special-interests/#462c223225f4
https://www.forbes.com/sites/norbertmichel/2019/01/14/bipartisan-housing-finance-reform-a-blatant-giveaway-to-special-interests/#462c223225f4
https://www.heritage.org/article/new-housing-reform-package-naked-giveaway-special-interests
https://www.heritage.org/article/new-housing-reform-package-naked-giveaway-special-interests
https://www.jchs.harvard.edu/blog/temporarily-ending-the-gse-net-worth-sweep-a-limited-but-important-step-towards-gse-reform/
https://www.jchs.harvard.edu/blog/temporarily-ending-the-gse-net-worth-sweep-a-limited-but-important-step-towards-gse-reform/
https://www.forbes.com/sites/norbertmichel/2019/07/15/the-best-housing-finance-reform-options-for-the-trump-administration/#414c62f87d3f
10
Here’s a quick rundown of the multiple taxpayer bailouts that helped
Fannie and Freddie get to where they are today. (More detail is available in
this new Heritage Foundation Backgrounder.)
11
In September 2008 Treasury bailed out Fannie and Freddie, promising to
shore up each with as much as $100 billion. In return, they forced the
companies to give Treasury 1 million shares of preferred stock, worth a total of
$1 billion. These shares required the companies to pay quarterly cash
dividends to the Treasury, and they included a protection device called a
liquidation preference. This device means that the companies cannot raise
new equity capital without first paying back the liquidation preference (now
approximately $200 billion).
12
In May of 2009, the companies were still struggling, so Treasury promised
to provide each with up to $200 billion.
13
In December 2009 the companies were still struggling, so Treasury changed
its commitment formula, allowing it to provide more than $200 billion.
14
Even after these three bailouts, Fannie and Freddie were still struggling in
2012—so much, that they faced the prospect of borrowing from Treasury just
to pay the dividends they owed Treasury.
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2008-9-26_SPSPA_FreddieMac_RestatedAgreement_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-5-6_SPSPA_FannieMae_Amendment_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-5-6_SPSPA_FannieMae_Amendment_508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-12-24_SPSPA_FreddieMac_Amendment2_N508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2009-12-24_SPSPA_FreddieMac_Amendment2_N508
15
Papering over this problem, Treasury amended the agreement once again,
this time taking any profit that Fannie and Freddie managed to earn in order
to satisfy the dividend payments.
16
It is true that, between 2008 and 2018, Fannie and Freddie paid back about
$300 billion to Treasury, roughly $100 billion more in dividends than they
received from Treasury. But this fact merely addresses the cash flows. It
overlooks that Fannie and Freddie were able to pay these dividends only with
the aid of successive bailouts, and it also ignores the risk that taxpayers were
forced to take on through these bailouts.
17
Of course, these four bailouts are separate from the additional help that
Fannie and Freddie received when the Fed and Treasury purchased trillions of
dollars of Fannie’s and Freddie’s bonds and mortgage backed securities, thus
staving off further losses that could have required even more bailouts.
18
Despite all of these bailouts, the federal government chose to place Fannie
and Freddie into conservatorship (to preserve their assets) rather than
receivership (to liquidate their assets and shut them down). Conservatorship
was a bad choice in 2008 because Fannie and Freddie had blown through
their capital buffer and had no prospects for building capital without
additional support from taxpayers.
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2012-8-17_SPSPA_FreddieMac_Amendment3_N508
https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/2012-8-17_SPSPA_FreddieMac_Amendment3_N508
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_2
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_2
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_1
http://gcfp.mit.edu/wp-content/uploads/2018/11/Lucas-Bailouts-Nov2018
https://www.federalreserve.gov/newsevents/pressreleases/monetary20081125b.htm
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_3
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Current_Market_Data-2016-02-19
https://www.fhfa.gov/DataTools/Downloads/Documents/Market-Data/Table_4b
19
Now that the FHFA is taking its job seriously and trying to get Fannie and
Freddie out of conservatorship, lack of capital is a major hurdle to a smooth
exit. Before they can exit, Fannie and Freddie will have to meet their capital
requirements (which were suspended throughout the conservatorship), and
the FHFA director will have to classify them as either: (1) adequately
capitalized, (2) undercapitalized, (3) significantly undercapitalized, or (4)
critically undercapitalized.
20
As this new paper explains, the authority of the FHFA director to intervene
in Fannie’s and Freddie’s operations widens as the capital classification
deteriorates. Ultimately, the director has the discretionary power to place the
GSEs into receivership and liquidate their assets if they are classified as
critically undercapitalized.
21
As the paper also shows, Fannie and Freddie are critically undercapitalized
by (combined) approximately $200 billion. This shortfall is a major hurdle to
exiting conservatorship, so there was a great buzz when the FHFA and
Treasury recently agreed to allow Fannie and Freddie to retain some of their
profits and maintain capital reserves of $25 billion and $20 billion,
respectively.
22
If, however, retained earnings are the firms’ only source of capital, it could
take close to decade to build the required amount. And that’s if everything
goes well.
https://www.law.cornell.edu/uscode/text/12/4614
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.law.cornell.edu/uscode/text/12/4614
https://www.marketwatch.com/story/fannie-freddie-can-hold-more-capital-per-treasury-fhfa-agreement-2019-09-30
23
So it would seem that the companies will have to raise capital from outside
sources, with a public offering. That option, however, also has a few major
hurdles. First, given that $200 billion dwarfs the largest public equity
offerings in history, it is not clear that the companies can pull this off even if
they build capital through retained earnings for the next several years.
24
A bigger problem is that the liquidation preference, the mechanism that is
supposed to protect taxpayers’ investment, now sits at approximately $200
billion. As the agreement with Treasury stands, to protect taxpayers, Fannie
and Freddie cannot exit conservatorship until the liquidation preference is
paid off.
25
So the companies actually need to raise about $400 billion in equity.
26
It may be argued that the most politically expedient option is to provide yet
another bailout so that the companies no longer have to pay off the liquidation
preference. There is, however, a much better solution to this problem.
● Reinstate capital standards for Fannie and Freddie.
● Place Fannie and Freddie into receivership and liquidate their
assets because they are critically undercapitalized.
27
These moves will cause a firestorm, but it doesn’t really matter: The FHFA
director has legal authority to take these steps, and it’s what should have been
done in 2008. Besides, anything the administration does to shrink Fannie and
https://www.investopedia.com/articles/investing/011215/top-10-largest-global-ipos-all-time.asp
https://www.investopedia.com/articles/investing/011215/top-10-largest-global-ipos-all-time.asp
https://www.heritage.org/markets-and-finance/report/revising-the-preferred-stock-purchase-agreements-fannie-mae-and-freddie
https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Issues-Proposed-Rule-on-Enterprise-Capital.aspx
https://www.marketwatch.com/story/fannie-freddie-overhaul-could-mean-windfall-for-preferred-stock-analyst-says-2019-07-12
https://www.marketwatch.com/story/fannie-freddie-overhaul-could-mean-windfall-for-preferred-stock-analyst-says-2019-07-12
Freddie’s footprint will cause a firestorm. (The shareholders can still have
their day in court no matter what.)
28
Liquidating the two companies would have been the right thing to do in
2008, and it is still the right thing to do. This government-protected duopoly
prevents the housing finance market from being competitive and better
serving customers’ needs. As the FHFA has said, a competitive market helps
people because it “effectively delivers market-affordable prices with customer
satisfaction and continual innovation to improve product quality.”
Follow me on Twitter.
Norbert Michel
I am the Director of the Center for Data Analysis at The Heritage Foundation. I also research issues
pertaining to financial markets and monetary policy
https://www.heritage.org/housing/report/taking-stock-shareholder-lawsuits-no-barrier-gse-dissolution
https://www.heritage.org/housing/report/taking-stock-shareholder-lawsuits-no-barrier-gse-dissolution
https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan
https://www.twitter.com/@norbertjmichel
https://www.forbes.com/sites/norbertmichel/
https://www.forbes.com/sites/norbertmichel/
TooBig to Fail: Journal Review #5
Read and annotate this article about Fannie Mae and Freddie Mac. Then answer the questions.
1. What are three new words you learned from this article? Write the word, part of speech
and definition below:
2. What is the author’s claim?
3. What are some pieces of support the author uses to support his claim?
4. Do you agree or disagree with the author? Why? Explain your ideas in about 3-5
sentences.
5. How is this article related to the field of business? Explain your ideas in about 3-5
sentences.
Word
Part of speech
(n, v, adj, etc)
Definition in your
own words
https://docs.google.com/document/d/1fN53yOs-aGT1iGYjyYTcXaykxNHbH7xvbM_kr3YS-LM/edit?usp=sharing