Feds to Fannie and Freddie: Give Us Profits, Not Dividends

Published August 21, 2012

The Obama administration, without action by Congress, has restructured terms of the federal government’s bailout of Fannie Mae and Freddie Mac, the government-sponsored mortgage behemoths that went into government conservatorship in 2008.

The federal government has pumped approximately $188 billion into the two companies to keep them afloat. In exchange for rescuing Fannie and Freddie the Treasury Department received senior preferred shares of stock that pay a 10 percent dividend. Until recently Fannie and Freddie had been performing so poorly they had been borrowing from the Treasury Department to make their quarterly dividend payments. But their financial performance has been improving of late.

The restructured agreement will end the quarterly dividend payments. Instead, the government will take any profits Fannie and Freddie earn. However, if their financial performance again turns bad and profits do not materialize, the government will receive no payments.

“With today’s announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac while continuing to support the necessary process of repair and recovery of the housing market,” said Michael Stegman, who serves as Treasury Secretary Timothy Geithner’s counselor on housing policy, in announcing the change.

Others are not so sanguine about the move.

16 Million Still Underwater

“My first thought [upon learning of the government’s restructuring of the Fannie Mae and Freddie Mac bailouts] was, ‘Pay back the government? How?’ In the last quarter Fannie and Freddie earned a profit, but one quarter doesn’t make a trend,” said Douglas French, president of the Mises Institute in Auburn, Alabama, and author of Walk Away: The Rise and Fall of the Home-Ownership Myth.

“With 16 million homes underwater in the U.S. there is more bad housing news to come,” French said. “It’s inconceivable that the housing market has fully corrected with mortgage rates forced down to 3.5 percent.”

Fannie Mae and Freddie Mac reported profits of $5.1 billion and $3 billion, respectively, in the second quarter of this year. Both entities also reported smaller profits in the first quarter: $2.7 billion and $577 million, respectively.

Immediately after news of the restructuring of the agreement broke, shares of Fannie Mae and Freddie Mac stock crashed more than 50 percent.

“It certainly reduces the options to ever see value in those securities,” Jim Vogel, an interest-rate strategist at FTN Financial in Memphis, Tennessee, told The Wall Street Journal.

‘Effort to Limit Taxpayers Exposure’

The restructuring “is a clear and appropriate effort to limit taxpayer exposure resulting from the federal government’s investment in Fannie Mae and Freddie Mac,” said Mortgage Bankers Association president and CEO David H. Stevens in a statement.

“We support efforts to protect the taxpayers, but want to emphasize the importance of ensuring continued liquidity that will provide the affordable mortgage financing necessary to support the housing market,” Stevens said. “It is critical that the transition of Fannie Mae and Freddie Mac’s role in financing real estate does not limit the availability, or increase the cost, of financing.”

“Much more work needs to be done to reform the secondary market [for mortgage-backed securities], but today’s announcement helps move this process forward and ensure the taxpayers’ investment is ultimately repaid,” said Frank Keating, president and CEO of the American Bankers Association, in a statement.

Skeptical Republican Leaders

Doubters abound.

House Financial Services Chairman Spencer Bachus (R-AL) told reporters the revamped agreement would actually increase the chances taxpayers will never recover the money that has been spent to bail out Fannie Mae and Freddie Mac. He said the change also “blunts efforts to reform Fannie and Freddie by fostering the false impression they are healthy institutions that should be restored to their previous status.”

Senate Republican leader Mitch McConnell of Kentucky also noted the Obama administration’s end run around Congress: “The Obama administration should stop delaying efforts to work with Congress to end these failed institutions, protect American taxpayers and develop a sustainable long-term plan for reform,” he told reporters.

The Mises Institute’s French said the administration’s move ignores economic realities of the housing market.

Overvalued Assets

“There are hundreds of thousands of homeowners in Las Vegas alone who haven’t made a mortgage payment in two or three years, unmolested by their mortgage servicers. I can’t imagine that Fannie’s or Freddie’s assets are worth what they say they are,” French said.  

“Instead of being put in government receivership, Fannie and Freddie should be allowed to fail. The assets [mortgages] could then be sold in a bankruptcy auction to bidders in the private market. Underwater mortgages would not sell for 100 cents on the dollar but instead for a fraction of that. The buyers of these mortgages would quickly go to homeowners and reset the principal amounts to more reflect economic reality. This would ‘reboot’ the housing/mortgage market, if you will.”

In a Bloomberg View editorial, writer Deborah Solomon noted, “While Treasury deserves some credit for at least moving the ball forward, it is also ensuring Fannie and Freddie remain wards of the state until something else takes their place.”

French had a similar view: “Fannie and Freddie will be wards of the state forever. It’s even possible home finance is formally taken over by the federal government with the apologists claiming mortgage finance is a ‘market failure'” when in fact it is a failure of government interventions in and manipulations of the housing market, he said.