The Fannie and Freddie Conservatorship: Bankruptcy Without Rules

The Fannie and Freddie Conservatorship: Bankruptcy Without Rules

Slush Fund. Say it with us: Slush. Fund.

Those two words are the only two words that come to mind when certain bureaucrats think of Fannie Mae and Freddie Mac. Otherwise, they would free them from the shackles of the conservatorship. Putting aside the need – and yes, we agree there is a need – for overall reform of the government-sponsored enterprises, Fannie and Freddie are doing quite well, and have been doing quite well for some time now. In fact, as Investors Unite Executive Director Tim Pagliara likes to say, there’s only one kind of institution that repays a $187.5 billion loan at 10 percent interest in under four years: the kind that didn’t need it in the first place.

Cliff Rossi, former Chief Risk Officer for Citigroup’s Consumer Lending Group, authored an op-ed in today’s American Banker that puts to rest of the misunderstanding that the only way out of the conservatorship is through congressional action or the courts. In fact, it is fully within the scope of the Federal Housing Finance Agency to end the conservatorship, which would resolve a lot of the outstanding issues to shareholders and protect taxpayers. Dr. Rossi is also the Executive in Residence and Professor of the Practice at the Robert H. Smith School of Business at the University of Maryland, and last week, he presented a paper on this topic at an Investors Unite event on Capitol Hill in Washington, D.C.

From Dr. Rossi’s op-ed in today’s American Banker:

“One approach to accelerating a recapitalization of the GSEs would be to cancel the Treasury’s senior preferred stock by declaring it “paid back,” re-characterizing past payments of the profit sweep (minus the 10% dividend sweep) as a paydown of principal. The value from that cancellation would flow up through to the remaining common stock, benefitting the Treasury as owner of 80% of the common stock through the warrants that it still would hold.

“Taking the step to end the conservatorship and recapitalize Fannie and Freddie is in the best interest of the taxpayers by monetizing a substantial profit from their investment in the GSEs over the last six years. And with changes already in place, coupled with strict risk-based capital rules, this step would virtually eliminate future taxpayer exposure to housing crises.”

Lawmakers have been vocal in their criticism of the firm “no release” policy FHFA seems to have taken on the conservatorship, which at this point is nothing more than a bankruptcy without any rules. For example, Congressman Maxine Waters (D-CA) served in Congress with FHFA Director Watt, who represented parts of North Carolina in the House before being appointed to the FHFA post, and understands the harm in a permanent conservatorship. She is also a passionate voice for minorities, many of whom are seeing even fewer opportunities for home ownership as Fannie and Freddie linger in bureaucratic limbo. Dr. Rossi goes on:

“As many, including Congresswoman Maxine Waters, have noted, the conservatorship — now in its sixth year — was never meant to be permanent; nor was the government’s 100% profit sweep meant to be perpetual. With the agencies in conservatorship, the federal government has effectively engineered a redistribution of capital out of housing and into the budgetary ether to help cover costs associated with the payroll tax cut extension through higher guarantee fees and by siphoning off profits from the companies well in excess of the costs incurred by the government to cover GSE credit losses.

“To date the agencies have paid back either through dividend or profit sweeps a total of $218.7 billion against draws of $189.4 billion, putting the taxpayer back in the black. That’s without taking into account the value of the preferred shares or warrants received by Treasury that give the holder the option to purchase up to nearly 80% of the common stock of both companies. Conservative estimates on the preferred share and warrants provide another $200 billion or more to the taxpayer.”

Another former U.S. House colleague of Watt’s, Eva Clayton, authored an op-ed recently in the Charlotte (North Carolina) Observer:

“The conversation has floundered on finding the best policy prescription to reform Fannie Mae and Freddie Mac in a way that prevents the organizations from further burdening taxpayers, while putting in place housing policy that builds wealth for communities and families. Regrettably, this is typical Washington: trying to solve problems that don’t exist or pushing a legislative solution that addresses the wrong problem.

“There is an immediate and clear path forward. It begins with ending the federal government’s conservatorship of Fannie and Freddie and thereby allowing them to rebuild and flourish in the marketplace.”

Despite the preponderance of voices calling for an end to the conservatorship – and an end the illegal takings under the Third Amendment – we can certainly understand government bureaucrats’ opposition to it. After all, with Fannie and Freddie continuing to send tens of millions of dollars to the U.S. Treasury general fund, Treasury can claim the deficit isn’t as bad as it actually is. And so we end this exactly where we began: SLUSH. FUND.