THE BLOG
08/23/2012 09:54 am ET | Updated Oct 23, 2012

Freaky Friday

It must have seemed like "Freaky Friday" to the Treasury Department last week after it announced that the government is replacing the 10 percent quarterly compounding dividend it's been charging Fannie Mae and Freddie Mac with a sweep of all of Fannie Mae's and Freddie Mac's profits for the next four years. Republican congressional leaders attacked the move, the conservative commentator Peter Wallison lauded it, and Democratic congressional leaders ignored it.

It's not every day that the U.S. Government effectively takes over private companies. The Administration actually has worked very hard to avoid it in the case of auto companies and other failed financial services companies that got bailed out. But Fannie and Freddie are now working 24/7 for the American taxpayer. And the change greatly reduces the likelihood that they will need further capital infusions to cover their guarantees, further protecting taxpayers.

Think of this as the part in the gangland movie when the loan shark informs the hapless borrower that they've run out of time to repay and the Mob is now taking over their business.

You'd think that those who have been the fiercest critics of the GSEs and the rescue of their MBS investors through Treasury capital infusions would be ecstatic. No more capital infusions. All profits flowing to the taxpayer. No qualification that the sweeps will end when the total principal already invested is paid off. Plus a clear statement that the Administration is committed to winding down the companies and an acceleration of the mandated run-off of their portfolios.

But that's not how it worked out on Freaky Friday.

Instead, Republican congressional leaders attacked the decision, accusing the Administration of prolonging a bail out and denying taxpayers full repayment for the $188 billion that has been extended to the companies to back their guarantees of nearly $5 trillion in outstanding mortgage backed securities.

"The reduction of the dividend payments for Fannie Mae and Freddie Mac will ensure the American taxpayers remain on the hook for the bailout of these two failed institutions for the foreseeable future," said Rep. Scott Garrett (R-NJ) in a press release. The chairman of the Capital Markets Subcommittee of the House Financial Services Committee continued, "The crony-capitalism that has become a centerpiece of the Administration's failed economic policy must come to an end." His colleague Rep. Spencer Bachus (R-AL), Chairman of the full House committee, added in his own release that "Eliminating the dividend that is owed to taxpayers irresponsibly benefits speculators and pre-conservatorship GSE stockholders at the expense of the American public."

"Crony capitalism?" The only cronies this move benefits are taxpayers, for whom the two companies are now working full time: "... benefits speculators and preconservatorship GSE stockholders... ?" The Administration's move actually finishes off any hopes speculators might still have had. Common shares of the companies remain around $0.25, about where they were before the announcement and down from around $80 per share in 2004. heir perpetual preferred stock, privately held mostly by speculators hoping the companies would eventually be rebooted as private entities, fell 55 percent on the announcement. The companies are dead meat for investors until a "final solution" is crafted. Even then, the Administration has made it clear that Fannie and Freddie as they existed before the financial meltdown are dead and gone.

Garrett's and Bachus' central complaint, that the Administration has not offered a comprehensive exit strategy and new mortgage finance system design, can't be denied. The Administration said as much themselves calling the change an interim step on the road to a full decommissioning of the companies. Of course, although these members are in the House majority, Republicans there also have failed to produce any legislation at the full Committee level to move past the current situation.

Meanwhile, over at the American Enterprise Institute (AEI), the deep well of conservative thought and anti-GSE advocacy from which House Republicans usually drink heartily, senior scholar Peter Wallison was singing a different tune. In an interview with BloombergBusinessWeek.com, Wallison said:

The most significant issue here is whether Fannie and Freddie will come back to life because their profits will enable them to re-capitalize themselves and then it will look as though it is feasible for them to return as private companies backed by the government. What the Treasury Department seems to be doing here, and I think it's a really good idea, is to deprive them of all their capital so that doesn't happen.

Meanwhile, House and Senate Democrats, and Senate Republican leaders on the Banking Committee have been shrouded in radio silence. I searched their websites and Google News for quotes or reactions and found none. Even the normally irrepressible Sen. Chuck Schumer (D-NY) took a pass on the issue.

Freaky Friday, indeed.

Market Response

The biggest driver of the Treasury's changed policy was the looming cap on new capital infusions that takes effect at the end of this year. Market fears that this cap might erode the effective government guarantee behind GSE mortgage-backed securities had widened spreads between GSE bonds and Ginnie Mae bonds. The latter carry an unambiguous full faith and credit guarantee. The Treasury strategy seems to have worked, at least initially. BloombergBusinessWeek.com reported on Aug. 17 that spreads had narrowed, albeit by only a small amount, in the immediate wake of the announcement. An analyst quoted in the article speculated that some buyers who have been wary of the GSE bonds because of the potential cap on Treasury support would be more likely to return after the announcement.