Government’s Actions “Bizarre” and “Un-American” in Fortune’s Survey of GSE Saga
- November 20, 2015
A comprehensive look at the long and ongoing conservatorship of Fannie Mae and Freddie Mac published by Fortune and written by Roger Parloff sheds needed new light on how the government continues to harm average investors and fails to provide a convincing rationale for its actions.
In essence, the story explains how investors large and small, who saw a legitimate investment opportunity in buying inexpensive shares of stocks with solid prospects, continue to be abused by federal government officials who have their own dubious agenda. The Third Amendment Sweep and obfuscation by the government is an affront to the rule of law and market principles, so the article should raise the ire of Fortune’s discerning readership and resonate broadly with average Americans.
The story, which will appear in the December 1 print edition of Fortune, recalls how, when the housing market was starting to collapse in the spring of 2008, James Lockhart, Fannie and Freddie’s chief regulator, signaled the GSEs were fine and even allowed them to issue new shares to the public. He dismissed talk of them needing a bailout as “nonsense.”
Therefore, when Fannie issued $7.4 billion in preferred stock a few months later, retired police officer Jim Vreeland and his wife Pandora purchased $65,000 worth of the GSE’s stock for about $25 a share to provide additional retirement income security.
In September 2008, when Congress and Treasury officials saw a wider systemic collapse as a real possibility, the Housing and Economic Recovery Act (HERA) went into effect and with terms that are now well known: Fannie and Freddie issued senior preferred stock to the Treasury. This would allow them to draw cash in an emergency. With the interest of taxpayers in mind, Fannie and Freddie would owe a 10% dividend on whatever money they needed to draw. Plus, Treasury received warrants to buy 79.9% of each GSE’s common stock at a nominal price.
It was a dramatic move but it seemed like a win for all parties concerned. The GSEs, long the centerpiece of a stable, liquid secondary mortgage market, would get back on their feet. Shareholders, who took as solid the government’s commitment to preserve the GSEs, would eventually see their investment pay off. Prospective homebuyers would be able to continue securing mortgages. Taxpayer losses would be minimized and, last but not least, the government would have potentially lucrative warrants.
Investors Unite President Tim Pagliara was interviewed for the story and spoke for many investors in acknowledging he felt like the government’s reaction was “overblown.” (Indeed, we now know the “death spiral” narrative the government has long relied on to justify its actions was hyperbolic.) Nonetheless, the government’s unprecedented actions to shore up Fannie and Freddie gave him and others ample reason to believe the government would recapitalize and release the GSEs to perform their time-honored market functions. That is, after all, what the law required.
But that is not how the law was followed. In August 2012, when the GSEs were again generating profits and “soundness and safety” were in reach, Treasury imposed the Third Amendment Sweep, denying the GSEs their capital, shareholders their rights and taxpayers their confidence in believing they would not have to subsidize another bailout. The article concludes this was “superfluous, if not downright bizarre.”
Bizarre and very harmful to average investors who unloaded shares at a loss or who continue to wait. The value of the shares is a tiny fraction of the purchase price and shareholders remain in limbo. “It was a big loss to a small guy,” Jim Vreeland is quoted as saying. “That was the money I was supposed to live on.”
Bethany McLean, author of “Shaky Ground: The Strange Saga of the U.S. Mortgage Giants,” conceded in the story that the conservatorship might have made sense in the tumult of the fall of 2008, but what has happened in the interim is hard to fathom.
“I have a hard time arguing with things done in the fog of war,” she is quoted in the story. “But morally, the third amendment was done in a calm and happy time. It was calculated. The reason that has been articulated for it does not make sense, and it’s pretty clearly not true. That’s incredibly unpleasant for anybody that cares about the abuse of government power.”
Parloff sums up the saga at the start of the piece in a comment that says it all.
“If this strikes you as, well, un-American, you’re not alone,” he wrote.