Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets,discuses Antonio Weiss and Michael Stegman’s argument about the recapitalization of Fannie Mae and Freddie Mac in an email sent to investors.

The Conflict

Antonio Weiss and Michael Stegman both work at the U.S. Treasury Department. They have been writing op-ed commentaries and giving speeches defining why the President will not “recap and release” the government sponsored enterprises (GSE) – i.e., allow Fannie Mae and Freddie Mac to recapitalize and be released from the conservatorship set up to manage them.

Trevor Thompson created a video on YouTube which outlines the opposite point of view. Working with a number of civil rights groups, including the NAACP, Mr. Thompson is arguing that it is critical for the GSEs to be recapped and released or many Americans will lose access to home ownership.

Off-Track

It is, of course, very positive for both sides to take their arguments to the public. In this fashion, a reasonable solution might possibly be reached that will resolve the GSE question. However, if both sides raise issues that are very close to being untruthful nothing realistic will emerge from the discussion. Unfortunately, this appears to be the case at present on both sides.

Fannie Mae and Freddie Mac: Weiss – Stegman

A key element in the Weiss – Stegman argument is that the American taxpayer was forced to take over Fannie Mae and Freddie Mac in 2008 because they were about to go bankrupt. Moreover, these gentlemen argue that the GSEs were about to fail due to the greed of their managements and stockholders; a greed which drove them to buy sub-prime, predatory mortgages.

The problem with these arguments is that enough forensic accountants have taken a look at Fannie Mae’s and Freddie Mac’s financials to indicate that these companies were not on the verge of bankruptcy, nor were they insolvent in 2008. Further, the argument that greed drove bad decision making completely ignores the fact that the government mandated that these companies weaken their underwriting standards to increase home ownership among lower income groups.

It is further difficult to understand why Weis – Stegman argue that these companies have not paid the government enough for the help they received or why private shareholders deserve nothing for their investments in these companies.

Civil Rights Groups

The civil rights groups choose to blame the Republicans and the big banks for attempting to destroy Fannie Mae and Freddie Mac. They are particularly resentful of the actions of the big banks who they claim are lobbying hard to eliminate the two agencies.

The position of these groups has popular appeal because it is in the DNA of any American that if you blame a bank everyone will immediately adopt your position. The fact here, however, is that the big banks understand that Fannie Mae and Freddie Mac assist their business. As one banker explained to me, Americans want long duration mortgages with fixed rates. To eliminate these instruments is to cause financial problems in housing. Another pointed out that these mortgage products attract customers who can be cross-sold other banking products that are more profitable.

Thus, the long duration fixed rate mortgage can be used to attract more business. Since the banks will make these loans but do not want to own them, they need Fannie Mae and Freddie Mac to buy the loans once they have been underwritten.

Stagnation

The issue as to what to do with these companies has a reached a point of stasis. The legislators do not want to touch the issue nor does the President. The courts are moving at a glacial pace to make decisions on the growing number of lawsuits that have been introduced. Now spurious arguments have been thrown into the mix making decision making even more difficult. This will be a long “war.”

In the meantime, Fannie Mae and Freddie Mac will continue to operate and the debt obligation that their guarantees create will grow the U.S. government debt. At some point this debt must be recognized as that of the U.S. taxpayer. So both sides are creating a problem that neither side wants.

Fannie Mae Bethany McLean
Fannie Mae