If you believe the definition of insanity, according to Albert Einstein it’s doing the same thing over and over and expecting different results, then you know the U.S. government is insane the way they let Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac run the mortgage market.
But you may not know the same GSE insanity that caused the 2008 financial crisis and the Great Recession turned into a government slush fund and that greed is making both politicians and the mortgage market even more insane.
Good Intentions Can Have Insane Consequences
Back in 1938, at the tail end of the Great Depression, as borrowers defaulted on mortgages and banks found themselves strapped for cash, President Franklin D. Roosevelt and Congress created the Federal National Mortgage Association, better known as Fannie Mae, to buy mortgages from lenders to free up bank capital going to other borrowers.
Fannie Mae paved the way for a new generation of American home ownership by encouraging banks to loan money to low- and middle-income buyers who otherwise might not have been considered creditworthy.
The Government Sponsored Enterprise grew so large that in 1968 President Lyndon Johnson took Fannie Mae’s debt portfolio off the government balance sheet by converting the enterprise into a publicly traded company owned by investors.
Two years later, the Federal Home Loan Mortgage Corporation, better known as Freddie Mac, was launched to keep Fannie Mae from functioning as a monopoly. Freddie Mac went public in 1989.
The two GSEs, technically private but assumed to be 100% backed by the taxing power of the United States government, don’t create mortgages; they buy them and guarantee them.
Mortgages originated by banks and other lenders that conform to GSE standards are technically guaranteed by the GSEs.
Fannie and Freddie, along with investment banks and others, today package mortgages into mortgage-backed securities (MBS) and sell them to investors, thus freeing up capital at originating banks and lenders so they can make more loans.
The GSEs also buy the mortgage-backed securities they create and huge amounts of MBS that others create.
They can buy trillions of dollars’ worth because their cost of capital is cheap. That’s because when they go into the bond market to borrow, investors believe they are 100% government-backed, if not 100% implied to be backed, and, therefore, an excellent credit whose bonds investors eagerly bought up.
At least, that’s how it used to be.
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Too Big to Fail and Too Greedy for Their Own Good
When the financial crisis broke in 2008, the two GSEs had more than $1.2 trillion in bonds outstanding, the proceeds from which they bought MBS with.
They had also effectively guaranteed $3.7 trillion worth of mortgages, which, of course, they bought because of their implicit guarantee, which in turn they could use as collateral when issuing bonds.
In other words, the terrible twosome owned or guaranteed more than 40% of all mortgage debt in the United States.
When home prices dropped in the blink of an eye, eventually falling 26% nationally and as much as 50% in some areas like Las Vegas, the two greedy GSE’s dove into insolvency.
As it turns out, they were guaranteed not to fail.
Fannie needed an immediate $112.4 billion rescue and Freddie needed an immediate $71.6 billion.
All told, Fannie needed $167.3 billion in bailout money and Freddie needed $119.8 billion.
Politicians were so mad that they demanded the Treasury make the GSEs pay for their greed, so the bailout money was constituted into senior preferred 10% coupon loan money.
Being the only game in town, especially since the rest of the mortgage market had imploded in a worse way than even the GSEs (thanks to their government backing), the terrible twosome not only survived but eventually thrived.
No, they weren’t public entities anymore. They were government wards in conservatorship.
As the mortgage market healed, profitability returned to the GSEs.
By 2012, not only were they in much better shape, easily paying 10% interest on their preferred notes, the Obama Administration ripped up the senior preferred note arrangement and demanded the two “agencies” now pay Treasury 100% of their profits.
Then in 2017, the Treasury and the Federal Housing Finance Agency (an independent federal agency created in 2008 as the successor regulatory agency of the Federal Housing Finance Board (FHFB), the Office of Federal Housing Enterprise Oversight (OFHEO), and the U.S. Department of Housing and Urban Development government-sponsored enterprise mission team, absorbing the powers and regulatory authority of both entities, with expanded legal and regulatory authority, including the ability to place government sponsored enterprises into receivership or conservatorship) let the two keep up to $3 billion in capital, to make it look like they were off the dole and had their own capital.
The ruse was just to make the two GSEs look better to the public.
In fact, they were much, much better. They were paying the Treasury billions of dollars annually.
The two GSEs, now responsible for more than 53% of mortgages in the United States, with only $3 billion in capital between them, have paid the Treasury all the money they needed in in their bailouts, and then some.
Based on numbers that came out at the end of the first quarter of 2019, since Fannie’s bailout totaling $167.3 billion, it has paid Treasury $279.7 billion. That’s a profit of $112.4 billion and counting. Freddie took $119.8 billion and has paid Treasury $191.4 billion, yielding a profit of $71.6 billion, and counting.
The U.S. government just used Public Law 99-514 to order Fannie and Freddie to distribute the nearly $72 billion pool of money.
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