Fannie Mae, Freddie Mac Deal Raises Troubling Issues

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When the US Senate Banking Committee announced plans to replace Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) with a new government backed program, shares of the stocks dropped dramatically, down nearly 15% on Wednesday and off more than 30% the day previous as rumors had been swirling.  While the measure had bipartisan participation from the Obama administration, the bill’s passage is uncertain.  If it does pass, Congress must then decide on “fair” treatment for investors.

The bill might not get attention before political leaders start to consider elections, according to a Bloomberg report.  Once it does receive attention there is no guarantee that the program will receive a warm reception in Congress.  A Democratic Senate aide was quoted in the report saying leadership is currently unenthusiastic about legislation that would eliminate Fannie Mae and Freddie Mac.

“It’s possible, but it’s certainly not probable,” Mark Calabria, a former aide on the Senate banking panel who now directs financial regulation studies at the Cato Institute, was quoted in the report saying. “You’re looking at maybe a 10 percent chance of a bill getting to the president’s desk.”

Toomey seeks “fair” treatment for investors, hits raw topic of validity of government contract

In regards to “fair” treatment for investors, Sen. Patrick Toomey (R-PA) is pushing a contentious issue on the floor of the Senate.  Speaking with US Treasury Secretary Jack Lew, Toomey touched on what could be a key issue. 

At issue is a contract the government signed and then later rescinded without involvement of the other party to the agreement, an act that would be illegal in the private sector.

“When the government stepped in and bailed out Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), they signed a very specific agreement with the board of directors, which they entered into voluntarily,” Toomey said in Senate questioning of Lew.  “This agreement involves the government providing guarantees and a line of credit and a very specific return.  The government would receive a 10% return on the money it extended and options to purchase 79% of Fannie Mae and Freddie Mac.”

The agreement between the board of directors and shareholders was clear, until the government changed the terms without any agreement of the board of directors or representatives of shareholders.  “In August of 2012, just as it was becoming apparent that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) were going to return to significant profitability, the government came along and negotiated a new deal with itself,” Toomey said, highlighting the unusual situation.  “With the treasury secretary on one side and a government appointed regulator on the other side, they wrote a new agreement whereby the government now gets 100% of the profits, when the previous agreement stipulated the government would have ownership of just under 80%.”

Breach of contract?

Then Toomey asked the money question.  “Isn’t this a serious breach of the sanctity of contracts and doesn’t this undermine our commitment to the rule of law to have done this?”

Lew avoided the question, but ultimately Toomey wouldn’t let it go.

“We have had a very clear policy on Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), which is we are winding them down.  This is important because we are making progress on a bipartisan basis to work on housing finance reform,” said Lew, not addressing the key issue of the government violating a written agreement.

“When the American people… can’t have confidence in a contract they have with the US government, I think that has a chilling effect on our economy”

“When you look at the agreements that were made for the federal government to step in and become a conservator and subsequent agreements that were made, it serves the public interest,” he said, addressing the written agreement but not answering the core question about the validity of the agreement.  “The sooner we get on with the debate about housing finance reform the better.”

Then Lew moved to change the issue.  “We sent clear signals of what our policy path was, so no one was not informed of what the goal was.  The damage done to our economy because of the failures of Fannie and Freddie were deep and I think the policies in place were right.”

After Lew attempted to change the topic to Ukraine, Toomey asked a follow up question that again wasn’t answered.  “Whatever signals you sent about policy cannot be more important than a contract that has been signed,” Toomey questions, hitting on the core issue once again.  “When the American people… can’t have confidence in a contract they have with the US government, I think that has a chilling effect on our economy and our ability to attract private capital to housing reform.”

After this Toomey’s time had expired and Lew avoided answering the key question.

(Here is a link to the video.  The interaction starts at 1 hour and 12 minutes into the testimony.)

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About the Author

Mark Melin
Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com

1 Comment on "Fannie Mae, Freddie Mac Deal Raises Troubling Issues"

  1. Richard Thompson | Mar 14, 2014, 12:48 am at 12:48 am |

    You bet Lew avoided answering questions! The Government Accountability Office, Harvard Joint Center for Housing Studies, and the Federal Housing Finance Agency concluded Fannie and Freddie were not to blame for the financial crisis. The Financial Crisis Inquiry Commission concluded they contributed to the crisis but were not the primary case. The cause of the subprime crisis was congressional policy which compromised underwriting standards, private banks seizing the opportunity to sell Fannie and Freddie junk mortgages, and new home owners with unrealistic expectations. You have your elected officials to thank for this mess dating back to the Clinton administration. Things escalated under Bush’s watch and they crashed the economy in 2008 only to seize, as of Q4 earnings announced last month, the most profitable company in the world. What you are looking at is a crime scene, not a bailout. Now they want Fannie and Freddie dead under the guise of ‘protecting the tax payer’ so they can bury the evidence piling up against them which will become clear to all in the coming weeks as Fairholme Funds was granted discovery in the lawsuit challenging their illegal profit sweep of shareholder owned companies. Their bill calls for eliminating a 5.3 trillion dollar enterprise simply to replace it with a system that does the same thing. Trust me, one way or another the tax payer is still ‘on the hook’ and if they get this wrong the whole economy is going down. This is a wake up call and could set a major precedence going forward. It could be Apple or Exxon they grab next. The government has crossed the line. This issue should blur party-political lines. I can not support a democrat or republican foolish enough to compromise our housing industry and economy or participate in a gross violation of our Constitution with respect to property rights

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