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Garrett Johnson

Garrett Johnson

Posted: March 6, 2010 04:30 PM

Let me take you back to Christmas Eve, 2009. It was a time to wrap gifts for loved-ones. That's how the Obama Administration felt about the financial industry when it lifted all caps in emergency bailout money to Fannie Mae and Freddie Mac. That means the taxpayer was on the hook for all losses at these two mortgage giants no matter how large the losses. The move caused a slight stir, but never got the attention of the American public because the announcement was timed to coincide with the peak season of distraction. And so it was forgotten ... but not by Fannie and Freddie.

On eight maids a milking day, also known as New Year's Day, Fannie Mae took advantage of this generosity.

"Effective Jan. 1, 2010, Fannie Mae brought an additional $2.4 trillion of its guaranty book of business on to the balance sheet under SFAS 166/167. Therefore, Fannie Mae expects to reflect approximately 18 million loans on its books compared with approximately two million loans as of Dec. 31, 2009. Management estimates that the cumulative effect of adopting FAS 166/167 will boost its net worth by $2 billion to $4 billion in its first-quarter 2010 results."

Stop! Hold the phone. What this statement indicates is that Fannie Mae, the largest mortgage company in the entire world, was holding eight times the amount of mortgages off-book than it had on-book.

Thus, despite the fact that it is losing tens of billions of dollars every quarter, and has borrowed $76.2 billion so far, it was actually hiding the vast majority of its worst performing mortgages off-book. The only reason you move assets off-book is if they are illiquid. And that's not even taking into account Freddie Mac, which has borrowed another $50 Billion from the taxpayers so far.

How bad are those assets? It's hard to say for certain, but after moving $2.4 Trillion dollars worth of assets, the net worth of Fannie Mae only improved by $2 Billion, or 0.083% of the assets.

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Just how much is the taxpayer is on the hook for? Well, the former caps were limited to $200 Billion a piece, which the Treasury decided just wasn't enough. So if the losses are north of $400 Billion then we are entering the range of TARP bailout, but with almost none of the press coverage. Or to put it another way: "The taxpayer bailout of Fannie Mae and Freddie Mac will almost certainly be the most expensive of the financial crisis..." There has been at least one attempt at estimating the losses.

"The Congressional Budget Office estimates that Fannie and Freddie added $291 billion to the federal deficit in 2009 and will cost an additional $389 billion to run over the next ten years. However, Fannie and Freddie are currently considered "off budget" meaning the actual cost to run these agencies is not considered by the Office of Management and Budget."

This article contains two nuggets of information. For of all, we are looking at around $600 Billion in taxpayer bailout, assuming the market doesn't take another sharp downturn. That's nothing to sneeze at, and it certainly deserves a lot more press coverage than it has gotten. The second nugget is that all these losses are consider off-budget. So what we are talking about is moving hundreds of billions of dollars of bad assets from off-budget Fannie Mae to off-budget Treasury Department.

This accounting gimmick has disturbing parallels to another contemporary crisis. "It is the same sort of financial shell game that has brought governments like Greece to a crisis point. Hiding your debts just leads to a bigger day of financial reckoning down the road," said Representative Spencer Bachus. Bachus may be a Republican who supported fighting two wars off-budget, but in this case he is 100% correct. Hiding debts off-budget is exactly what broke the Greek government.

The Republicans are pushing to have the money put on-budget which would, of course, immediately blow out the federal borrowing limits. After weeks of pressing by the Republicans, the Obama Administration has finally agreed to consider it.

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A carefully designed disaster

The collapse of Fannie and Freddie didn't start recently, and didn't happen by accident. It was a calculated decision by the Bush Administration to try to extend and pretend the housing crisis into the next administration. It all started in March 2008:

"By reducing the extra cushion of capital the two companies have been required to hold since 2004, the regulator, the Office of Federal Housing Enterprise Oversight, is enabling the companies to invest $200 billion more in home loans. In essence, the companies are being allowed to take billions of dollars that had been used as a reserve against possible further losses and invest that money now in the housing market. But critics said that if the housing market continued to decline, the move could put the two companies on a less sure footing and ultimately require a huge taxpayer bailout. 'I think it's very dangerous and it's a sign that people are very frightened,' said Thomas H. Stanton, an expert on the two companies who teaches a course on credit risk at Johns Hopkins University. 'At a time in which finance companies are holding questionable assets and facing losses, regulators typically require more capital, not less.'"

On top of that, the size of the mortgages that Fannie and Freddie were allowed to buy was increased, from $417,000 to $729,750. This change happened in the face of collapsing asset prices.

Homes worth nearly 3/4 of a million dollars are not part of the original reasons why Fannie Mae and Freddie Mac were created, nor should they be. People that can afford homes of that price do not need public subsidies, nor should they get it.

"Now, thanks to Congress, junk bond investors will be able to pawn off their bad debt to Fannie and Freddie, instead of suing the big investment houses for ripping them off. This shift will certainly doom Fannie Mae and Freddie Mac, so don't be surprised if we, the taxpayers, have to bail out poor Fannie and Freddie - to the tune of more than $1 trillion."

It was a risky gamble, and it failed. Spectacularly.The balance sheet of Fannie and Freddie that was cut 6 months earlier was now in danger of collapse.It seems that the thin layer of cash reserves left over after the Bush Administration cut it 6 months earlier, wasn't enough to cover their massive losses. Yet the financial media failed to note that the Bush Administration was partly responsible for this enormous calamity.

But the Bush Administration was going to make it right. They were going to backstop Fannie and Freddie and calm investors ... at least that was the plan.

"The powers Paulson won from Congress last month enabling a government rescue of Freddie Mac and Fannie Mae -- authority he likened to a weapon whose mere existence made it unlikely it would have to be fired -- may end up making a bailout more likely, say analysts and investors.

They say the threat of government action is creating uncertainty that is raising the companies' borrowing costs and increasing the odds Fannie and Freddie will need taxpayer funding."

The problem with the bailout plan is that Paulson is the implied threat of a de facto nationalization of the two mortgage giants. This would leave existing shareholders with pennies on the dollar. Thus the bailout plan that Bush and Paulson assured us they would never have to do, caused stock prices of Fannie and Freddie to crater. This reduced their capital reserves even further, increasing the chances of a taxpayer bailout.

On the other side of the ledger, the Bush Administration also changed the rules in April 2008 to get the FHA more involved in the mortgage industry. According to James Bianco, "The government was using the Federal Home Loan Banks as a way to bail out the banking system early on."

One forgotten scandal was from late September 2008, the FHLB of Atlanta loaned Countrywide Financial $51 Billion in exchange for questionable mortgages as collateral. Countrywide went under shortly afterward.

The decision to increase the FHA's exposure to a collapsing housing market is now meeting its limits.

"The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market's recovery.

About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency's figures show.

If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses -- a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

Adding to the trouble was a now-defunct FHA program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble. The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said.

The program in question was another Bush Administration idea to bail out the housing industry to the benefit of Wall Street.

Meet the New Boss

After inheriting this disastrous legacy from the Bush Administration, you could only assume that the Obama Administration would do things drastically different, right?

"Fannie Mae will drop some credit-score requirements, reduce income-documentation standards and waive the need for appraisals in some cases, according to a notice yesterday to lenders posted on the Washington-based company's Web site. The changes apply to loans that the company owns or guarantees."

Let me translate for you. "Drop credit-score requirements" equals subprime. "Reduce income-documentation standards" equals liar loans.

And it just keeps getting better. The Obama Administration plans to subsidize at-risk borrowers. Has anyone bothered to ask "How long?" Meanwhile the Fed is buying up all those subprime, liar-loans that Fannie and Freddie are pumping out.

On top of it, the next part of Obama's plan had a ring of familiarity to it: "The loan-to-value (LTV) limit on mortgages Fannie Mae and Freddie Mac will be able to refinance as part of Obama's Homeowner Affordability and Stability Plan may go higher than the original 105 percent, according to National Mortgage News." Bush's disastrous legacy was to at first ignore the bubble, then to try to keep it inflated until he was out of office by using Fannie and Freddie. Obama's plan is to use taxpayer money to subsidize sub-prime, liar-loans at more than 105% of the home's value with Fannie and Freddie as a conduit. Thus attempting to recreate all the properties of the bubble that got us into trouble in the first place.

Seriously. Is this the best that Washington can do? Is our leadership really this bankrupt of ideas?

One other item to note is that when the Obama Administration lifted all bailout caps, they also promised that plans on reforming Fannie and Freddie would be drawn up by February. Last week, that promise was broken.

"The Obama administration will wait until 2011 to propose an overhaul of mortgage giants Fannie Mae and Freddie Mac, Treasury Secretary Timothy Geithner said yesterday, arguing that he wanted to put some distance between a new system and what he called 'the worst housing crisis in generations.'

'We can't do everything right away,'' he said."

We don't expect you to do "everything" Timmy. We only expect you to do your job, which includes coming up with plans to reform these companies within the 13 months that you previously promised.

Meanwhile, Fannie and Freddie continue to be traded on the stock exchange, hand out dividends to stock holders (while asking for taxpayer bailouts), and pay their CEOs as much as $6 million a year.