Ignoring Rule of Law Imperils Financial System, Former FDIC Chair on IU Member Call
- April 1, 2015
In the midst of the 2008 financial crisis, the government imposed a “tough deal” to shore up Fannie Mae and Freddie Mac and helped stabilize housing finance, but the government’s current actions are making it more likely there will be a another crisis and this one could be worse, warned former FDIC Chairman William Isaac on an Investors Unite conference call earlier today.
Mr. Isaac released a paper co-authored with former Sen. Bob Kerrey, “How the Fannie and Freddie Conservatorship Has Undermined the Resolution Process,” explaining the bad precedent set by the government when it enacted the Third Amendment Sweep in 2012. Isaac also highlighted his concerns in an op-ed published in today’s Wall Street Journal.
During the call, Mr. Isaac decried the lack of urgency on the part of regulators and policymakers in resolving the status of the GSEs from the conservatorship and diverting their capital to a variety of government budgetary needs.
“They are not toys for the government to play with,” he said.
During his chairmanship at the FDIC (1981-85), the nation’s seventh-largest bank – Continental Illinois – teetered on the edge of collapse. Within a few days of learning of the crisis, the FDIC moved to takeover the bank and set a new course for it; within the span of a few months, solutions, including a new Board of Directors, were in place, and over the next few years, the bank was reprivatized and eventually sold to Bank of America.
Beyond there being “no excuse” for the length of time the GSEs have been in limbo, Mr. Isaac said the government changing the terms of the deal it put into place in 2008 threatens the nation’s financial system.
“It’s not good policy. It doesn’t settle the market,” he said. “I’m always looking at the next crisis, and I don’t want to make the next crisis worse because of the actions taken during the current crisis.”
The specific actions he’s referring to are draining Fannie’s and Freddie’s capital reserves. In 2002, Fannie Mae had about $30 billion in equity and Freddie Mac had a similar level; by 2007, Fannie had increased that to $44 billion and Freddie was around $27 billion. Today, though, Fannie has just under $4 billion and Freddie is down to $2.6 billion. Those reserves will need to be replaced for the companies to be able to effectively operate in the market once the conservatorships end – something which should have happened years ago. That money, as we know, is going into the U.S. Treasury general fund where it’s being spent.
Investors Unite Executive Director Tim Pagliara, who hosted the conference call, called this “blatantly irresponsible.” In his opening remarks, Pagliara noted that at the time of the financial crisis, Fannie and Freddie were nearly 100-times leveraged; today, thanks to the illegal Third Amendment Sweep, they are 700-times leveraged with almost $5 trillion in liabilities.
An advisor to Investors Unite, Mr. Isaac commended Congresswoman Marsha Blackburn (R-TN) for recently introducing legislation that would place Fannie and Freddie into escrow until significant reforms are made. In his Wall Street Journal piece, Mr. Isaac wrote:
“Fannie and Freddie’s investors are justifiably outraged, and some of them have sued the government for its actions. But the public should also be concerned. By denying Fannie and Freddie the ability to accumulate capital, the government is putting taxpayers on the hook for any future losses they may incur.
“The Obama Treasury is ignoring the threat. A senior Treasury official, Michael Stegman, told a Goldman Sachs conference earlier this month that recapitalizing Fannie and Freddie would come at taxpayer ‘expense.’ The only logical reading of this analysis is that a dollar going to rebuilding capital is one less dollar going into the Treasury’s general fund. Mr. Stegman has it backward: The risk of another massive taxpayer bailout, arising from undercapitalization, is precisely why Treasury must end the net-worth sweep and allow Fannie and Freddie to emerge from the limbo of conservatorship.”
Mr. Isaac noted in both the op-ed and on the call that he supported the government’s “tough terms” when it effectively acquired ownership of 79 percent of the GSEs’ common stock. As structured, these terms avoided a complete government takeover of the GSEs and protected taxpayers from future bailouts but now, the Third Amendment sweep and inaction on the GSEs, it is the government that is not living up to the terms of the deal. And this sets a dangerous precedent, he warned.
“We’re losing sight of the rule of law, and the financial system won’t work without that,” he said.
Listen to a replay of the call here.