The Fannie May and Freddie Mac debacle; an engineered disaster

No man is happy without a delusion of some kind. Delusions are as necessary to our happiness as realities.
Christian Nevell Bovee, 1820-1904, American Author, Lawyer

The Fannie May and Freddie Mac debacle; an engineered disaster

Meanwhile, taxpayers have pumped more than $125 billion into the failed firms — and on the hook for many more after the administration promised an unlimited source of funds just before Christmas to backstop their growing losses. “We will do everything necessary to ensure these institutions have the capital they need to meet their commitments,” Geithner said in response to tough questions from Rep. Scott Garrett, a New Jersey Republican. Underscoring the need for change, Geithner acknowledged that taxpayers are likely to face “very substantial” losses on the government’s takeover of Fannie and Freddie.

Republicans on the panel want to dismantle Fannie and Freddie within five years, arguing that the government-backed firms cost taxpayers too much with little to show for it — hundreds of billions in taxpayer losses for a housing finance system rife with moral hazard issues and a crowding out of private companies from the market. Full Story

When Geithner states that they will do everything to make sure these institutions have the capital they need to function, he is stating that they are willing to use tax payer’s money to fund two worthless entities, instead of dismantling them. Trying to keep these agencies floating is akin to pouring money into a bottomless pit.

One of the old lines was that these two agencies helped make housing affordable by providing an avenue for individuals who would not normally qualify for a mortgage. The following quote was extracted from their site.

Fannie Mae works to increase the supply of affordable for-sale and for-rent housing

They do so by creating customized financing solutions for our housing partners. These financing solutions help ensure stable, livable neighbourhoods. Through multiple community development investment funds, Fannie Mae works to tear down barriers, lower costs and increase opportunity, for homeownership and affordable rental housing for all Americans. Full Story

They have been a failure in every sense of the word; in trying to provide affordable housing they indirectly provided banks with the incentive to sell as many mortgages as possible. As soon as the deal was closed the banks could get these mortgages off their books by dumping them onto these two agencies.

Some background info on these two companies

They were created by the Federal National Mortgage Association in the 1930’s to help speed up the homeownership process by buying mortgages from banks. Banks would normally sell a mortgage and then put it on their books; this means that each time they did so, a certain amount of capital was tied up and this limited the number of mortgages they could issue. Now they could simply issue a mortgage and sell it to Freddie or Fannie and as a result, banks could issue almost as many mortgages as they could sell.

Although they are private companies, they are government-sponsored enterprises established by federal law. As GSE’s they received special privileges, the main one being that if they were threatened with failure, the federal government would come to their rescue. This gave them the best of both worlds; profits are privatised, but losses are socialized. This guarantee encourages immoral and unconscionable behaviour because there is no downside; the downside becomes the government’s problem, which in turn becomes the tax payer’s problem.

Now let’s examine if they helped the public

Freddie Mac lost 50 billion last year but has now come begging to the government for another 31.8 billion and this comes on top of the 13.8 billion Freddie asked for last year. The government has pledged a massive 200 billion line of credit to support this disaster and based on all the talk so far; they would probably offer even more if Freddie ever needed it.

If we weigh the cost to the taxpayer and the so-called savings these two mortgage giants provided, one finds that they failed miserably and had provided no benefit at all. How can this be? The so-called benefits of offering lower mortgage rates have been offset by the cost of all the money taxpayers have poured into these two companies. They had access to money at a lower rate than private companies and could, in turn, pass these savings to the consumer; lenders provided them with lower rates because their survival was guaranteed by the Federal government. Based on the amount of money they have already asked for and the future amounts they will need to continue functioning, it is estimated that by the end of the year they will become net losers. In other words, they would have moved from providing some value to providing none at all.

Lawrence J. White an economist at the New York University (Stern School of business) states that the GSE’s could borrow money 35-40 basis points lower than the private sector. Thus if the standard rate was 6%, they paid only 5.60-5.65%.

At the end of 2008, these two companies had 31 million mortgages on their books, which were worth more than 5 trillion (actual figures were roughly in the 5.4-5.6 trillion ranges). Thus borrowers would have saved roughly 10 billion in 2008. According to Daniel Gross over the years, they supposedly produced savings of $100 billion.

If we compare this potential $100 billion in savings they have provided against the $300 billion-plus in financial support the Government has pledged to both these agencies, the conclusion is clear; these two companies have provided no benefit at all. In fact, one has to wonder why they continue to exist as they have now become a monumental liability. It is true they have not used up all the money the government has pledged to them (at least not yet) but at the rate, they are burning this money, it’s only a matter of time before they go through those funds before they start begging for more. Thus would it not be better to dismantle these two monstrosities and cut and end the haemorrhaging.

If one were to state that these guys had a large role to play in the financial crisis that hit this nation, one would not be too far off the mark. After all, they did provide banks with an incentive by virtually buying any crap that the banks were willing to throw at them.

The government is hell-bent on pouring good money into completely useless projects, but when it comes to helping individuals; they find ways to make painful cuts. Point and case, not approving a $250 checks for senior citizens. To make matters worse, they create money out of thin air to pay for these black hole projects, thereby further devaluing our currency and indirectly imposing a silent tax on the population. The only way investors can protect themselves under such conditions is to make sure that one puts a portion of one’s money into hard assets; the simplest way to do this would be to purchase some Gold, Silver or Palladium bullion.

The people of the world having once been deceived, suspect deceit in truth itself.
Hitopadesa, 600?-1100? AD, Sanskrit Fable From Panchatantra