How The Fannie Mae, Freddie Mac Conservatorship Has Undermined The Resolution Process
By William Isaac and Senator Bob Kerrey
Seven years after the crisis that rocked the global financial system, we are still rebuilding and redesigning its structure and rules – and probably will be for years to come. As policymakers engage in this process, laws enacted to address the crisis must be faithfully executed or formally amended.
Otherwise, the government would introduce uncertainty into a marketplace that can ill afford it. Regrettably, uncertainty is precisely what is occurring with regard to the mortgage banking giants commonly known as Fannie Mae and Freddie Mac.
In the summer of 2008, the world’s largest secondary financial market was unraveling. Given the size and systemic significance of Fannie Mae and Freddie Mac in the mortgage finance market, the Treasury Department intervened, based on authority granted to it by Congress in its passage of the Housing and Economic Recovery Act (HERA). Treasury invested $187 billion in senior preferred stock in Fannie Mae and Freddie Mac, carrying a ten percent dividend. As part of the deal, the government also 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. The government was right to insist on tough terms given its indispensable role in restoring stability into the marketplace.
However, given its critical role, the government has a uniquely important obligation to abide by the terms of deals that it makes. That is why the government’s actions in recent years are troubling. As this paper will detail, beginning in 2012 the government unilaterally changed the terms of HERA and began to sweep all of the GSE’s profits into the general fund. Rather than “conserving and preserving” the GSEs’ assets for their eventual restoration to a “safe and solvent” condition, as the HERA stipulates, the ongoing confiscation of 100% of the GSEs’ profits does just the opposite.
This misapplication of the law has created several problems. First, it ignores the rights of shareholders. Second, it leaves the GSEs’ vulnerable to the need for the infusion of taxpayer dollars should another market disruption occur.
Congress and the Administration will eventually decide what to do about Fannie and Freddie, and whether or not these institutions should have any role in the future of housing finance. Until that time, the government must follow the law, and not undercut its ability to act decisively in times of crisis.
The conservatorship established for Fannie Mae and Freddie Mac in the midst of the severe financial crisis of 2008-2009 initially helped stabilize housing finance, but in the years since has thwarted the clear direction provided by Congress to the Federal Housing Finance Agency (FHFA) under the Housing and Economic Recovery Act (“HERA”). The conservatorships were accompanied by an investment by the government of $187 billion in senior preferred stock in Fannie and Freddie carrying a 10% dividend. The government also obtained warrants, convertible at nominal cost, into 79% of Fannie Mae’s and Freddie Mac’s common stock.
Under HERA, one of FHFA’s primary duties as conservator is to “preserve and protect the assets and property” of the enterprises as well as to take actions necessary to putting Fannie and Freddie in a “safe and solvent” condition. In 2012, four years after FHFA established the conservatorships, the federal government unilaterally amended the agreements to sweep 100% of Fannie’s and Freddie’s profits to the U.S. Treasury. This action, and the resulting draining of the GSEs’ profits and capital each quarter, actually reduces the effectiveness of future resolution efforts by the government in times of crisis. Resolution of financial institutions by federal agencies often requires participation of the private sector. In turn, established rules and law surrounding the priority of claims in such arrangements depends on the consistent and clear application of these rules. By placing public claims ahead of private stakeholders in the Third Amendment to the preferred stock purchase agreements, the federal government has adversely affected future resolutions of financial institutions by changing the rules of the game by putting one group of legal stakeholders ahead of others ex post.
In the meantime, the conservatorships endure. With no hope of recapitalizing without extraordinary intervention, the secondary mortgage market remains in a state of suspended animation, lacking private capital, exposing taxpayers to future losses, and raising the cost of mortgage credit and reducing its availability to creditworthy borrowers.
Historic Context and Policy Perspectives
On September 6, 2008, the U.S. mortgage market – the world’s largest secondary financial market – avoided an unprecedented and catastrophic unraveling when both Fannie Mae and Freddie Mac were placed by their regulator into conservatorship. Conservatorship is a legal process taken by an entity at the time financial insolvency occurs to oversee its activities in an effort to return the company to solvency. Conservatorship is distinct from receivership, which is aimed more at an orderly liquidation of an enterprise that cannot be saved. The federal government, leading up to conservatorship, had few policy tools available to it to step in and provide stability to the GSEs.
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