Where did all the money go?
lost $2.3 BILLION dollars in the past three months, and its cousin
lost nearly $1 billion, bringing its one-year total loss to nearly $5 billion.
Just look around your neighborhood and see the foreclosed and for-sale houses -- all worth a lot less than the mortgage money borrowed to buy them. Add it all up, in neighborhoods across America, and you have all those billions in losses.
Since Fannie and Freddie are the centerpiece of our nation's housing finance industry, the losses -- and reserves for future losses -- congregate on their books. Since they have always had a "line of credit" to the government, recently made more explicit, their problems are
problems, as it looks more likely the two mortgage giants will need an official bailout.
What are Fannie and Freddie?
Just about everyone's heard of Freddie Mac and Fannie Mae -- but very few people understand what a significant role they play in financing home ownership in America. Even fewer understand how conflicted they are in their dual mission of supporting the housing market and acting as profitable businesses.
Actually, very few financial institutions can proudly point to their accomplishment of acting responsibly within their mandate when it comes to the housing loans they made. So many who should have known better opted to avoid looking at the reality of the loans they were making to people who had no down payment, no documented income, and no credit history.
At least Freddie Mac and Fannie Mae had the "excuse" that they were charged with "facilitating" home ownership across America, as well as making good business decisions. Still, in search of profits they expanded their portfolio of mortgages wildly, lowering their standards and pricing to compete in the marketplace.
How -- and Why - They Did It
Fannie and Freddie are both public companies, with public shareholders.
The two organizations buy loans originated by financial institutions, package them for sale, and then use the proceeds to underwrite even more mortgages -- keeping the mortgage market "liquid." In 2006, they underwrote about 40% of all mortgages. Today, it is closer to 90%, as the private securitization market has dried up in the wake of the credit market collapse.
But, in addition to being public companies, they are also GSE's -- government sponsored enterprises. That means they have been protected since 1968 by the support of the federal government in the form of a "line of credit" through the Treasury, exemption from state and local taxes, and from some
Securities and Exchange Commission
oversight, even though they are public companies.
That perception that they are "protected" by the government has enabled them to borrow money in the public markets at lower rates than private corporations.
It is the dual mission of these companies to act like real "businesses" and "help" Americans obtain homeownership, combined with their exemptions from SEC oversight, that has caused their problems.
How does a private company built to earn profits simultaneously serve a social good?
A Conflicted Mission
Here's a "mission statement" from the Freddie Mac Web site that will probably be erased when this column is published:
Freddie Mac is a shareholder-owned corporation whose people are dedicated to improving the quality of life by making the American dream of decent, accessible housing a reality. We accomplish this mission by linking Main Street to Wall Street -- purchasing, securitizing and investing in home mortgages, and ultimately providing homeowners and renters with lower housing costs and better access to home financing. Since our inception, Freddie Mac has achieved more than 30 consecutive years of profitability and financed one out of every six homes in America.
That dual mission -- helping home ownership and creating shareholder profits -- worked well when the housing market was booming, obscuring unwise decisions to purchase sub-prime and Alt-A mortgages. But when the bubble burst, the earnings referred to in their mission statement were replaced by huge losses.
Even worse, both Fannie and Freddie are projecting more losses, based on current default rates and the gloomy outlook for housing prices in the future. Estimates of an 18% to 20% decline in home prices, from top to bottom, are now common. The Case-Shiller index, which reflects all loans -- including riskier jumbo loans not purchased by Freddie and Fannie, shows a decline of 25% for home prices in some major urban areas.
Clearly, housing is not likely to rebound quickly. Equally clearly, the government will have to get involved.
When the president signed the housing bill on July 31, it included a provision that would allow the Treasury to buy the equity and debt (stock and bonds) of these companies as a way to keep them going, should they "run out " of capital. A week before that, the
gave the two companies access to borrowing at the Fed's discount window, something previously reserved for banks.
The Price of the Problem
Freddie Mac's stock is trading at $5.90 a share, down more than 80% from its high of $67 earlier this year. And Fannie ended the week at $9.05, down from a high of more than $70 in the past 12 months.
Both have slashed their dividend to five cents a share. They would have eliminated the dividend entirely, but many of their shareholders are institutions that are required to hold only dividend-paying stocks.
Both companies acknowledge the need to raise more capital -- at least $5 billion each -- but who would buy their stock, with such a gloomy outlook and the uncertainty about their future mission? It looks like the Treasury, using our tax dollars, will be the buyer of last resort to save them.
But save these GSE's -- for what purpose in the future?
A Critical Conflict
That is the key to the problem: defining their role, either as profit-making companies, or government do-good agencies supported by taxpayers. If you expect a company to act responsibly to its shareholders, then the management must be focused on that goal.
If there are dual goals, and they conflict, how can you please multiple constituencies? When they conflict, what can you expect?
Some in Congress are urging them to keep growing, just to keep the economy going, to restart the housing market, and restore the American dream of home ownership. You can understand why the politicians find this attractive in an election year. But to "rescue" housing, they'd have to once again guarantee loans to people who are truly a credit risk.
Instead, the chastened companies have belatedly tightened up on lending standards, which means higher rates and less availability of mortgages, in order to do the right thing by their shareholders. That's not pleasing the politicians.
Does it make sense to restart the housing market under the same system, with expanded guarantees against risk? Do we want to create that fiction again? I think not.
And that's The Savage Truth.
Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated. She was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. Savage currently serves as a director of the Chicago Mercantile Exchange Corp.