Freddie Mac Decides To Cut Funding To Treasury by Glen Bradford author of My first or second: I’m about who you’re about.
On September 6, 2008, the director of the Federal Housing Finance Agency (FHFA), James B. Lockhart III, announced his decision to place two Government-sponsored enterprises (GSEs), Fannie Mae (Federal National Mortgage Association) (OTCQB:FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation) (OTCQB:FMCC), into conservatorship run by the FHFA:
I support Secretary Paulson, the Administration, and the Federal Reserve in their efforts to stabilize the housing finance system.
Since the conservatorships began, Treasury has made cash money over $100B dollars by leveraging FHFA’s position as conservator to force the GSEs to generate massive fictitious accounting losses in spite of their consistent profitability throughout the crisis. As the saying goes, never let a good opportunity go to waste.
Never Let A Good Crisis Go To Waste
According to Bill Maloni who served Fannie Mae from 1983 to 2004, the gross numbers are $450 Billion in losses on $3 Trillion of private labeled mortgage backed securities from 2006-2008.
Effectively what you have here is a situation where everyone but the GSEs was committing massive mortgage fraud and when the tide went out everyone was left pointing the finger at each other. In coordinated fashion, Hank Paulson worked for his supporters to scapegoat the GSEs and reconstruct the record to make them look like they are to blame.
While both the agency and private label mortgage backed securities have lost massive amounts of money for taxpayers, agency mortgage backed securities offered by Fannie Mae and Freddie Mac have only lost massive amounts of money for taxpayers because tax collectors have reclassified their profits as government revenue. Although it is against the fifth amendment of the constitution to take property without just compensation, Judge Lamberth was able to dismiss a case late last year based primarily on an incomplete administrative record comprised of perjury by a since departed Mario Ugoletti, who is rumoured to have since secured private legal counsel. In this case, just compensation for Fannie Mae and Freddie Mac is $0 according to government officials whose primary defense is one of trying to hide the truth from the public eye. They aren’t saying that it doesn’t matter what they did, no one can stop them because HERA prohibits judicial review. Judge Sweeney doesn’t agree and has categorized the government’s arguments as schizophrenic.
The revolving door is in full swing. The lead government attorney Greg Schwind didn’t want to be involved any longer either. Neither is Edward Demarco, the man who signed at least one document that his successor Melvin L. Watt says trumps the law.
FHFA’s Fight For Fannie and Freddie
Since last year when analyst Richard X. Bove declared victory on Fannie Mae and Freddie Mac, Melvin L. Watt has been stirring the pot of controversy. He has been increasing wages and lawmakers have responded by working on laws to cap salaries of private companies.
The most recent move to use it’s accounting power to generate a loss not greater than Freddie Mac’s capital buffer cuts off funding for Treasury, which is at odds with the purpose of the third amendment net worth sweep. During the earlier years of conservatorship, FHFA forced the GSEs to recognize massive losses in their accounting statements even though the GSEs were making lots of money. This was to make the conservatorship warranted. During this time period the conservator forced the GSEs to take $132.2B of government money at a cost much higher than what was otherwise generally available to the companies. As the losses mounted, so too did the perpetual dividend to FHFA’s parent US Treasury and the size of the potential dividend was used for reasoning to institute the net worth sweep.
From the beginning of conservatorship, the Federal Government has taken more than $100B out of Fannie and Freddie on a net basis, showing how consistently profitable the twins have been. Meanwhile, the banks that caused the crisis in private label mortgage backed securities generating hundreds of billions of dollars in actual losses and in the process collapsing a market that has since ceased to exist in its private form continue to use Fannie Mae and Freddie Mac’s services to securities home mortgages because the banks don’t want them on their books. What is good for Fannie Mae and Freddie Mac is not good for the banks and that’s how Fannie and Freddie serve as sort of a counter-cyclical lender. They step in and fill the gap when the private market crumbles and are our hero’s from the last crisis.
FHFA’s Most Recent Move: STOP PMT
FHFA has gone back to reporting losses for at least Freddie and this is not a bad thing. FHFA has decided not to pay Treasury and instead let Freddie Mac retain capital this quarter. The way that this is done is that Freddie Mac must not exceed the limits of its capital buffer, which is somewhere between $0 and $1.8B. If It goes below, it is forced to draw and Affordable Housing Trusts do not get funded. If it goes over, it is forced to reclassify any overages as taxes payable to the government.
- Freddie Mac’s conservator the Federal Housing Finance Agency (FHFA) has been making all the accounting decisions for Fannie Mae and Freddie Mac since the twins have been coerced into conservatorship.
- Bank losses during the crisis totaled $1.1T and a majority of the big banks have had to pay cash to the GSEs to escape convictions of misrepresentational fraud.
- Instead of bleeding the companies dry by reporting massive incomes triggering cash dividends to Treasury, FHFA appears to be making an about-face by forcing the GSEs to retain capital.
As such, FHFA is finally being a conservator. By reporting financial results that minimize its involvement with Treasury, FHFA is making a good faith gesture that is is independent. The less money that Freddie Mac pays to US Treasury the more it retains and that’s a good thing and is diametrically opposed to the purpose of the net worth sweep:
Making sure that every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms.
By not reporting earnings by manipulating the accounting, FHFA is evading the stated purpose of the net worth sweep as outlined on the Treasury’s website.
Recent Courtroom Action
The government is trying to prevent the actual record of events from interfering with it’s purported administrative record as evidenced by recent legal filings:
Summary and Conclusion
Fannie Mae and Freddie Mac are currently forced to remit their net worth to US Treasury in a situation where their own conservator Melvin L. Watt continues to operate against an agreement that he says trumps the law. As long as Fannie and Freddie are treated like they are government agencies even though they are not, the shares are intrinsically worthless. Outside of that, as a regulated business their profits are set by congress and their share and capitalization structure is effectively set by FHFA. Last summer, Treasury was shopping around for a solution and the rumors are true that they have been looking into valuations of Fannie Mae and Freddie Mac.
There are hundreds of civil rights organizations that would love a piece of the action and the warrants can be assigned to anyone. Capital requirements can also be set so high that there is no question regarding their solvency except the rhetorical question.
The common shares are going to be worth whatever FHFA says they are worth and the preferred shares are going to be worth par. That’s my opinion and as such I own the preferreds. The only real question is one of timing and I think that we are closer than we ever have been before to resolution.
Disclosure: The author Glen Bradford is long Fannie and Freddie Preferred securities FMCKJ and FNMAS.