Farrell: Who Deserves the Pain? - TheStreet

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The

Fannie

(FNM)

and

Freddie

(FRE)

mess gets more annoyingly outrageous the more you look into it. This week's cover story in

The Economist

reminds us that "Capitalism rests on a clear principle: those who get the profits should take the pain." Shareholders, management and politicians all shared the profits from these semi-government agencies. They want the taxpayer to take the pain.

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Both companies were established to assist middle- and lower-middle-income families to achieve the dream of homeownership. The two "F's" were able to borrow money at below-market rates because they were deemed to be government-backed, and they are exempt from state and local taxes. They were allowed to operate with a thin slice of capital, far less than their competitors.

A 2005 study by the

Federal Reserve

figured those benefits were worth between $122 billion and $182 billion (yes, billion!). And the shareholders did indeed benefit, about half of that sum was paid out in dividends. Management benefited. The top five sharks at the head of Fannie received $199 million in compensation between 1998 and 2003. It was also during this time that management had the brilliant idea of buying mortgage bonds issued by others to arbitrage their low cost of borrowing against the high yields those bonds offered. Freddie went from $25 billion in other bonds held in 1998 to $267 billion by 2007. Fannie went from $18.5 billion to $127 billion during the same time. This boosted short-term profits, until the credit problems in these bonds came out. Even Alan Greenspan was incredulous when he said with his characteristic reserve that these purchases "do not appear to supply mortgage market liquidity or to enhance capital markets in the United States."

And the companies lived large and protected their growing franchise. In the past 10 years, some $170 million was spent on lobbying. How did this get anyone a mortgage? Several million was given to politicians' election campaigns. Even now, Freddie wants to continue to pay its $650 million annual dividend.

And these companies have a loaded gun to the taxpayer's head, since during this credit crunch they are responsible for buying 80% of mortgages recently issued. But "if you cannot let firms fail in a bust, you must contain them," says

The Economist

. Make them eliminate dividends on the common stock, force them to issue massively dilutive equity offerings, eliminate all lobbying and political contributions and make them take the pain before any taxpayer money is used to support their efforts. It's enough to irritate you.

What would go far in easing the pain is to take a trip to the movie theater to see

Mamma Mia

. All of us secretly love the music, which is cheesy to the

n

th degree but fun. The story line is nonexistent and Pierce Brosnan can't sing. But Meryl Streep is unreal, and the two hours fly by. A solid "A."

Vincent Farrell Jr. is a principal of Scotsman Capital Management. Prior to joining Scotsman in April 2005, Farrell was chairman of Victory Capital Management of Cleveland and chairman of Victory SBSF Capital Management in New York. He was a founding partner of Spears Benzak Salomon & Farrell, which was acquired by KeyCorp in 1995. Vince held a variety of positions in his 23 years at SBSF, including chief investment officer, and he served as the portfolio manager on a number of the firm's largest client relationships. He is a regular guest on CNBC as well as other national print and broadcast media.

Prior to joining SBSF, Vince spent nine years at Smith Barney as a vice president, sales.

Vince graduated from Princeton University in 1969 and received his MBA from the Iona College Graduate School of Business in 1972.