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.