Conflicted Out - Fannie and Freddie Should Serve Just One Master

Why are Fannie Mae and Freddie Mac, both government-sponsored and backed by taxpayer dollars, still publicly traded? The national discussion of the mortgage mess must consider the inherent conflict that exists when Fannie and Freddie serve two masters -- its shareholders and the American people.

Owning stock in Fannie and Freddie was a brilliant investment strategy from a shareholder perspective -- buy stock in a quasi-government agency that serves a captive consumer base, dependent on that same agency to provide liquidity to the national residential real estate market AND is backed by taxpayer dollars. For investors, this seemed like a "no-lose" proposition - but at the taxpayer's expense.

What went wrong? Congress is looking into predatory lenders and tightening regulatory oversight. However, lenders have to work within Fannie and Freddie's own guidelines or they can't sell the loans off in the secondary market.

The intense growth of secondary mortgage market opportunities may have been created by Fannie and Freddie in response to market demand. But could it be, however innocently, that Fannie and Freddie also created opportunities in the market to help move the stock? When a company trades publicly on an exchange, management must grow sales year-over-year to increase profitability. Trouble can brew when concern for shareholder value affects the underlying product. When you are talking about residential real estate loans sold into the secondary market, you have to lend more to make a better profit, create more loan products and find more people to buy them.

The goal for shareholders in a publicly traded company is to increase share value over time. The only way that happens is to create a product that is unique and then sell a whole lot of it. When sales wane, the stock price either stays put or goes down and the party is over for shareholders. If you invest in any stock, you want the price to go up and then - BAM! - take profits.

Before 1989, ownership of the stock in Freddie Mac was limited to financial institutions and a few others. Congress then allowed Freddie Mac to trade publicly. Freddie's chart has been simply gorgeous since then, on a steady rise until about 2001 when it started to hover, more or less, around the same price before it went down in 2003. It shot up again with the increase in the volume of sub-prime market lending. Now it is in the toilet.

During the years when Freddie's stock price wasn't moving in any significant direction and the Wall Street "Talking Heads" took note of this, company management must have felt some pressure to get the stock moving. Growth in secondary market sales would have been one way to raise the stock price. Of course, we now know that the key difference in this economic cycle is the massive increase in the amount of mortgage-backed securities issued in the secondary market. This created a revolving door of liquidity that was almost too good to be true. The lenders kept on lending -- to anyone and everyone they could place in a loan.

Returning Fannie and Freddie to closely-held status, monitored away from the frenzy of public exchanges and Wall Street analysts, would not affect liquidity in the national real estate market because sales of loan portfolios to the secondary market would continue unchanged. However, company management would no longer have to be concerned about the stock price, shareholder value, and meeting regulatory reporting requirements for publicly traded companies. Instead, they could focus on the original -- public -- mission of both entities -- providing liquidity to the national real estate market.

Comments

[iambusto]

sometime i am amazed at the ignorance of the regular joe.

whenever we hear "bailout" it USUALLY means bondholder bailout. rarely does it mean shareholder bailout. reason is that when the govt. takes over a company or a company enters reorganization, equity holders usually get wiped out pretty much 100% of the time.

its the bondholders who are getting bailed out. and thats appropriate.

does that make me a republican? No.

FNM and FRE did business for decades under the general market assumption that they had the implied backing of the US govt. their cost of capital was lower than regular banks for same reason. if govt. has no intention of ever bailing out these two entitites, then from the begining it should have made it clear.

[dadw5boys]

Republicans have wanted to destroy Fannie Mae and Freddie Mac since they came into existence.

Banks want to rule the USA.

[nezumi]

I just read the latest on this issue:
http://www.reuters.com/article/ousiv/idUSN1747783620080817

Seems like a share issuing solution is sought (the gov. is buying selfdevised shares on taxpayers money). A seizing or nationalization of F&F is apparently avoided to prevent the official acceptance of the liabilities of F&F which in effect would double the fiscal deficit (they apparently are this large). However, regardless of the cosmetics the liabilities are not going away.

If this share issuing solution ensures total control of F&F by the government so as to avoid further losses, it is a de facto nationalizaiton. The regular share holders also appear to not loose everything either, which might be good as far as international funds are involved. This looks actually like a very very smart solution. Wow, learnt something here.

[Sheila Tendy - Huffpost Blogger]

Nezumi,

Thanks for you interest and taking the time to research the issue further! Way back when Fannie and Freddie were given the latitude to trade publicly, the market for mortgage backed securities didn't exist the way it does today. It has grown so much in this cycle and has become incredibly complex. While no one wants to see a taxpayer bailout, to some extent it may be necessary to get Fannie and Freddie back on its feet again, especially if funds have dried up from other sources. There are many moving parts in this analysis and each one is complicated. The folks working on this have to consider the impact on the overall markets as well. My purpose in writing this post in to get people thinking about the structure of government sponsored entities.

What really matters in the short term is the impact on homeowners who are facing foreclosure as a result of being placed in loans they couldn't afford or didn't understand. You should read my blog on being on the other side of this issue as a borrower: My Lesson Learned - Simple Tips to Prevent Your From Losing Your Shirt.

[Badbone]

Why are they both publicly traded and government financed? Because that’s the way things get done in new America.

It’s the best of both worlds for big business. Make money and you get to keep it (almost tax free). Lose money, and you get a taxpayer funded bailout.

Private profits, public losses. Welcome to new America, taxpayer.

[nezumi]

I also found it astonishing that 'buying shares' was one of the measures congress agreed upon in using to bail out F&F. Wait a minuit: buy shares of a (maybe soon) bankrupt institution? This way the money would go directly to the share holders and not to the ailing company you want to help? Is it only me not seeing the light? The only conceivable reason to do this is to protect share holder wealth.

The 'normal way of things' would be: F&F finally becomes insolvent, the government jumps in, guarantees their liabilties and closes shop (and seizing all remaining assets, of course). The share holders would see nothing. Now, is it especially dangerous for the economy if some well-off people lose some money? Are they also 'too big to fail'?

[Desmo]

A equity holder bailout is not really a concern right now because the stock is almost worthless. The bondholders are really the ones being bailed out.