Richard X. Bove of Rafferty Capital Markets comments on Senator Charles Grassley’s requests for information concerning Fannie Mae and Freddie Mac.
Approximately 3 weeks ago, Senator Charles Grassley (R., IA), Chairman of the Senate Judiciary Committee, sent letters to both the Departments of the Treasury and Justice asking specific questions concerning Fannie Mae & Freddie Mac (F&F). The Department of Justice has not responded as yet but the Treasury has. The response did not come from the Treasury Secretary who had received the letter but rather the Acting Assistant Secretary for Legislative Affairs. I am not sure how protocol works in Washington D.C. but the response from this source and not the Secretary to whom the letter was written does not appear to be totally appropriate.
The letter does not answer two of the Senator’s requests for information:
- It does not specify who in the Administration has invoked Presidential Privilege in a court case in front of the Federal Claims Court in Washington D.C. Was it the President, someone in the Treasury Department, or someone in the Justice Department? No one knows and to this point no one is telling.
- Second, how has the relationship between the Treasury Department and the Federal Housing Finance Agency (FHFA) changed following the restructuring of the terms of the Senior Preferred Stock held by Fannie Mae and Freddie Mac?
Other questions were answered. However, before dealing with the Treasury’s response it may make sense to restate some of what I believe to be facts pertinent to this exchange of correspondence.
In the comments below my opinion is shown in italics (see Addendum for more specific breakdown).
- Treasury outlays to Fannie Mae and Freddie Mac between the 3rd quarter of 2008 and the 2nd Quarter of 2012
- Fannie Mae: $117.1 billion
- Freddie Mac: $72.3 billion
- Total: $189.5 billion
- Payments to date
- Based on current values
- Cash: $227.3 billion
- Preferred Stock: $189.5 billion
- Warrants: $19.2 billion
- Total: $436.0 billion
- Based on estimated market values
- Cash: $227.3 billion
- Preferred Stock: $475.0 billion
- Warrants: $33.9 billion
- Total: $736.2 Billion
- Profit to taxpayer
- Based on current values: $246.5 billion
- Based on estimated market values: $546.7 billion
- Based on current values
Calculating the Repayment to the Treasury
The letter starts out by arguing that the Treasury deserved to be repaid for the risk it took, and was taking, by making funds available to Fannie Mae and Freddie Mac. No one disagrees with that view. The problem here is that the Treasury only refers to the cash dividends it received. It does not here, and nowhere else, admit to the fact that no matter how one calculates it, the senior preferred and the warrants have value. One might speculate that the reason that no value is ascribed to these instruments is that
- The Treasury intends to wipe them out without allowing taxpayers to be compensated for what they own – i.e., these instruments, and
- The Treasury is driving Fannie Mae and Freddie Mac into insolvency with its current policies of pushing F&F’s combined capital to zero.
Need for Additional Funds
Quoting from the letter to Senator Grassley:
“The enterprises projected that, for the foreseeable future, they [F&F] would be unable to pay the 10-percent dividends [on the senior preferred] without taking additional draws.”
Payment in Kind
The first problem with this statement is that a number of legal experts have argued that Fannie Mae and Freddie Mac were not under any obligation to make the 10% payment in cash. They could have made the payment in kind – i.e., more preferred stock. They were under no obligation to draw any money from the Treasury to make cash payments on the Senior Preferred. If the legal scholars are correct in their statements then the Treasury’s comment to Senator Grassley is simply factually incorrect.
Apparently the foreseeable future, referred to above, lasts about six months in Treasury’s reckoning. Starting in the first quarter of 2013, five months after the Treasury’s foreseeable future prediction, Fannie Mae and Freddie Mac jumped their payments to the Treasury more than meaningfully. In the next 5 quarters. In total:
- Fannie Mae paid the Treasury $85.4 billion in cash
- Freddie Mac paid $58.0 billion.
In total these two companies, which were supposedly about to go bankrupt and in needing more money from the Treasury, paid the Treasury $143.4 billion in cash. This statement by the Treasury that it feared that F&F would run out of money is either the greatest mistake in the history of cash flow analysis or in the history of accounting or dissembling. The ability of Fannie Mae and Freddie Mac to pay this money also raises questions as to whether these companies ever needed the amount of Treasury funding that was paid out if they had been looked at on a cash flow basis.
The next sentence in the Treasury’s letter is totally baffling. It states:
“The Third Amendment [to the Senior Preferred] replaced the 10-percent fixed dividends with a formula under which each enterprise pays Treasury, as a dividend, the amount by which its net worth for the quarter exceeds a set capital reserve.”
The Treasury, working with the FHFA, has established the common equity for the year 2018 to be zero for both of these companies. To get to zero, these companies must pay more than their earnings every quarter in dividends and they do. The Treasury has mandated that Fannie Mae and Freddie Mac become insolvent.
To state that this is totally contrary to the requirements of the Housing and Economic Recovery Act of 2008 is at best an understatement, at worst a Democratic Administration disregarding the mandate of a Democratic Congress. It was the clear intent of HERA to return Fannie Mae and Freddie Mac to solvency and then free it from its conservativeship. The fact that the government is driving F&F into insolvency makes this next sentence from the letter even more perplexing:
“… in April 2014, FHFA released projections of the enterprises’ financial performance which predicted future draws from Treasury under specific economic scenarios and demonstrated the possibility of continued taxpayer support in spite of the earnings recorded that year.”
This is clearly Orwellian “Newspeak.” The dividends paid to the Treasury plus the drawdowns in Fannie Mae and Freddie Mac’s common equity are the reason that these two companies will need more capital. If the Treasury did not take all of the retained earnings and common equity of the companies there would be no need for any Treasury draws in the future. This statement in this letter is simply inconceivable.
Who Owns Fannie Mae and Freddie Mac?
Now we need to look at a longer quote:
“In addition, the amount of taxpayer support provided by the preferred stock agreements far exceeds the $187.5 billion in funding capacity drawn by the enterprises to date.
First, today, Treasury continues to make available to Fannie and Freddie more than $258 billion in undrawn funding capacity, meaning Treasury and the taxpayers continue to be on the hook for future losses those enterprises may incur.”
What??? The numbers are very clear. The Treasury has received a profit of $246.5 billion on their $189.5 (not $187.5) billion investment in Fannie Mae and Freddie Mac if one ignores market values. If one considers market values, and my estimates are valid, then the Treasury’s profit is $546.7 billion. These numbers beggar the Treasury’s argument that it is on the hook for $258 billion.
Remember while the government continues to argue that the taxpayer is at risk here, the taxpayer is the owner of Fannie and Freddie by virtue of the government’s warrant position. The taxpayer effectively owns 79.9% of both companies. While the Treasury continues to savage these companies remember that it is savaging the taxpayer who owns these companies.
In fact, remember these guys and gals known as the American people? Where do they stand in this battle?
Well for one thing they own Senior Preferred shares in F&F that under the worst of conditions pays them 10% of $190 billion every year in perpetuity. The Treasury is driving as hard as it can, as evidenced by this letter to Senator Grassley, to rob the American people of the ownership of these preferreds and of the dividends the preferreds can provide to them.
The Treasury is also intent on putting Fannie Mae and Freddie Mac into bankruptcy by taking away all of the retained earnings and common equity in these companies. It wants to rob the American people of their ownership of F&F.
Most important of all, however, when Fannie Mae and Freddie Mac are driven into bankruptcy there will be no entity willing to replace them in the private sector. There will be no 30-year fixed rate mortgages. What does this mean? First be aware that the Urban Institute claims that 87% of all purchase mortgages in this country are 30-year fixed rate mortgages. So taking away that instrument means that 7 of 8 home buyers in this country who now use the 30-year FRM to fund the purchase of their new home will be unable to do so.
They must use other financial instruments which require higher monthly payments. Or, they must buy lower cost houses. This would drive the price of all homes in this country lower. Now we are talking about hitting the American people for more than just their ownership of a senior preferred stock or of Fannie Mae and Freddie Mac. We are talking about causing an estimated trillion dollar plus loss in the wealth of the American people as the value of their homes declines.
In writing this letter to Senator Grassley, the Treasury Department has treated him and the institution he represents with the greatest disrespect possible. It will be interesting to note whether the Senator fades away on this issue or whether he intends to pursue the goal of moving the government away from newspeak to transparency in assessing the state of these two companies. My belief is that the Senator will not accept being treated in this fashion. Hearings are likely.