Fannie Mae, Freddie Mac Phobia is Madness by Glen Bradford

The purpose of this article is to illustrate the cost to wind down Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) is so great that it’s not really a tractable solution and as such, the equity is severely undervalued. The idea is that the cost of wind down is so large that, as we are seeing, billionaires are getting involved and setting things straight. Politicians love to see what they can get away with, but this time they have bitten off more than they can chew and the analogy is like a minnow trying to swallow an elephant.

As you will see, it would take an act of great financial retardation to chop down:

  1. A huge revenue source for American Taxpayers
  2. Home affordability
  3. Two enormously profitable companies with over 120 years of combined experience

The best way to begin illustrating the value created by Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) is to imagine that tomorrow you wake up and they no longer exist. What happens? The movie 28 Days later comes to mind. Things would get really bad really fast.

Home Affordability Plummets

Putting an end to Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) will increase the cost of taking out a mortgage. This will make homes less affordable. Dick Bove outlines that the median American household, in the absence of Fannie Mae and Freddie Mac, will be able to afford 20% less house. The math is as follows. At $51,000 per year, by his math, affordability drops from $435K to $345K.

The question that I am proposing is one that nobody seems to be asking: “How does this impact tax revenue?”

Fannie Mae, Freddie Mac wind down impact is Widespread

Because the secondary mortgage market contracted meaningfully over the last decade, a wind down of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) would impact the entire American middle class. As of the most recent Census, there are 114,800,000 U.S. Households.

Year Number of Households
2010 114,800,000
2005 108,800,000
2000 103,200,000
1995 97,700,000
1990 91,900,900
1980 80,800,000
1970 63,500,000
1960 52,600,000
1950 43,500,000
1940 34,900,000

The impact of the wind down would be put across roughly half of these. Based on the US income demographics chart below I’m figuring that 52% of households would be immediately impacted and would be able to afford 20% less house.

fannie mae

Now that we have a sample size of people that would be impacted and their median incomes, let’s take a look and see if we can ballpark an effective property tax across this group of people to calculate the tax revenue impact of dropping home affordability by 20% via the end of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC).

From the chart below, I have assumed that for math purposes a conservative estimate for property taxes would be 2.7% of income for the middle class.

fannie mae

(click to enlarge)

Middle Class Impact

Conservatively assuming that this only impacts the middle class, let’s take a look at income distribution in the United States and do some math:

114,800,000 households * (23%+18%+11% are middle class)*$50,054 median income * 2.7% = $81B/year in property taxes on this subset alone.

Governmental Impact

There are two components of tax revenue loss in this case. There is the run rate loss (A) and there is the one-time loss (B) because of tax write offs associated with capital losses. By my rough napkin math, the government will lose 20% of this tax revenue by winding down Fannie and Freddie, or $16B/year. If you capitalize this with a 14x multiple you get $224B. If you assume that home prices fall by this amount and the economy does not implode you are also looking at an estimated tax revenue loss in the amount of $254B, calculated as follows:

Median home price $213,400*20%*114,800,000 households * (23%+18%+11% are middle class) * 10% Effective Federal Tax rate on income.

The Lost Cost of a Going Concern

From a conservative investor standpoint, the losses for the government do not stop there because they potentially own 80% of the combined businesses. If you reference the value lost by not continuing the firms as a going concern, Bill Ackman on slide 105 puts the number somewhere between (C) $444B and $621B.

The Total Cost to the US Taxpayer

So far, I have outlined three Exhibits that will count towards losses in potential revenue for the US Taxpayer in the event that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are wound down. On top of that, you need to value the direct loss in home value, $2.5T calculated as follows:

Median home price $213,400*20%*114,800,000 households * (23%+18%+11% are middle class)

Total It Up

$224B+$254B+$444B+$2547B=$3.5T

If you spread that evenly across US Households the bill comes to $30,487, each. That is a price that I think many of us would prefer to not incur. This is why winding down Fannie and Freddie would result in the creation of neighborhoods of rental units aka instant slums.

It has been opined publicly, “How can we afford to continue on with Fannie Mae and Freddie Mac?” Gilbert Godfrey puts my candid perspective as eloquently as possible. You fool!

The Summary

The claim that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are not worth keeping around is a baseless opinion grounded in illusory ideas and not the reality that the world exists in today. Billionaires are getting involved and will see this through because it is profitable for them to involve themselves in this because the equity is seriously undervalued.

Making It Personal

I called my sister Julie, who just bought a house in Indianapolis, IN this past Spring and the truth of the matter is that her mortgage was financed by these beautiful companies. Until I made her investigate it, she had no idea. Meanwhile, she works as an accountant where she processes documents for the United States Department of Housing and Urban Development. I am just saying that most of the people that benefit, even the ones that probably ought to know, don’t know that they benefit directly from Fannie Mae and Freddie Mac’s existence.

That doesn’t even take into account the indirect benefit of being employed because the economy is healthy. The good work that they do behind the scenes is evidenced by the lack of private competition. They do what no one else dares to do at a great price and make a lot of money doing it. Without Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), the 2008-2009 crisis would have been so much deeper and prolonged that we’d probably still be dive bombing economically.

As a previous tenant in the city of gossip, Washington DC, I lived within a 10-minute walk of the White House. I’ve spent a lot of time trying to understand how all of this madness

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