Fannie and Freddie: Playing With a Stacked Deck

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As recently as February of this year, Russian officials cleared the way for two of its sovereign wealth funds, the Reserve Fund and National Wellbeing Fund, to invest in various foreign bonds, including those issued by the twin towers of American residential finance, Fannie and Freddie.

“The prospect for every GSE bond clearly states that it is not backed by the United States government,” says Matt Kibbe, president of FreedomWorks. “That’s why investors holding agency bonds already receive a significant risk premium over Treasuries.”

The Russians ignored the warnings and grabbed the risk premium. Today, fully 21% of Russia’s monetary reserves are invested in the obligations of Fannie, Freddie and the Home Loan Banks. And the largest holder of Fannie and Freddie debt is another friendly foreigner, China. The middle kingdom, according to the FreedomWorks organization, owns $376 billion worth of U.S. agency bonds. Altogether, foreigners hold $1.3 trillion of them.

Maybe the foreigners didn’t understand what they were getting into. Or maybe they did.

Franklin Delano Roosevelt, whose family had made a fortune in the opium trade, promised the nation a “New Deal” during the Great Depression of the ‘30s. But what he gave it was more like the old false shuffle. The president pulled cards from the bottom of the deck, pretending that government bureaucrats could do a better job of allocating capital than private investors. In 1938, he set up the Federal National Mortgage Association, b.k.a. Fannie Mae. Then, as now, the national housing market was in crisis. House prices had been declining for almost a decade. Who wanted to lend money against falling collateral values? Only a fool…or a government.

For the next 32 years, the firm resembled a nationwide savings and loan institution — borrowing from large institutions and lending to smaller ones, keeping a piece of the spread for its trouble. But Fannie Mae was an imposter from the get-go. Lenders knew that it had something no free market business ever had – the full faith and credit of the US government behind it. Fannie was able to borrow at below-market rates; lenders knew they had no risk of losing their money in a default or bankruptcy. Fannie, with the aces dealt her by the Roosevelt administration, dominated the business for the next 30 years.

Then, another crisis came along, followed by another bamboozle, this one perpetrated by Lyndon Johnson. Specifically, the feds were spending too much on wars – the War on Poverty at home…and one against the Viet Cong across the ocean. Victory eluded Lyndon Johnson on both fronts, but his handling of Fannie Mae should have brought him at least a bronze star. Attempting to balance the government’s ledgers (this was in the days when Americans still believed in balanced budgets), he moved the mortgage business off of the Federal government’s books, privatizing it as a ‘government sponsored agency.’ For good measure, he created a competing organization – the Federal Home Mortgage Association, b.k.a. Freddie Mac.

Many are the ham-fisted dictators and sticky-fingered kleptocrats who have nationalized industries. Even without a credit crunch for camouflage, Francois Mitterand nationalized 36 leading French banks in 1982. Robert Mugabe grabbed farmland in the Zimbabwe. Evo Morales took the gas industry. And Hugo Chavez seized the Orinoco oil fields in 2007. But Lyndon Johnson rarely gets credit for his great advance in the history of public larceny: he privatized the profits while nationalizing the losses. This formula has been a honey pot for clever dirigistes ever since, providing countless opportunities for defeated politicians, hacks and hustlers – speaking fees, consulting contracts, board memberships, bonuses, stock options (notably, the $170 million spent on lobbyists over the past 10 years…mentioned above) – things that wouldn’t be possible for a “public” company. In effect, Fannie Mae could pick the taxpayer’s pocket twice – once by sticking him with a mortgage he couldn’t rea lly afford and a second time by raiding the taxpayers’ vault for a bailout.

In the case at hand, by the year 2007, the CEOs of Fannie and Freddie were earning salaries that would have been respectable, even on Wall Street. Fannie’s main man, Daniel Mudd took home $13.4 million in 2007, a year in which the firm lost $2.1 billion. While the Freddie Kruger of mortgage finance, Dick Syron, pocketed $18.3 for helping Freddie Mac to a $3 billion loss and a 33% trim for the shareholders.

As recently as May of this year, Mr. Mudd told the New York Times that he was “seeing the best opportunities since I’ve been in this business.” Two months later, both Fannie and Freddie are “insolvent,” says former Fed governor William Poole.

In a better world, Mudd and Syron would be hanged…and the bondholders would be wiped out along with the shareholders. But last Sunday, U.S. Treasury Secretary Henry Paulson announced a bailout. And on Monday, an auction of Freddie Mac debt was oversubscribed. The Russians were right; the deck was stacked from the very beginning.

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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12 Comments on "Fannie and Freddie: Playing With a Stacked Deck"

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Coffee Addict
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The Russians knew and so did I. Invest in any failing “retail” financial institution with national importance and there will be a bailout. Bond holders and bottom feeding share holders get to enjoy a free ride.

christina
Guest

It’s like a house of cards that’s about to collapse.

Colby
Guest

I agree with the emphasis, and easy boat on which to jump with the latest market news. However the commentary from the author is strikingly emotive (and for good reason !) and dare I say historic in its review, what does it offer in terms of insight/prediction on the future…not much from where I sit…though been wrong before !

charles
Guest
What all you economic rationalist or whatever you like to call those who complain about the methods used to unwind the great depression forget, we got into that mess because people used the drugs you are prescribing. Put your money into non productive resources ( gold), unwind credit, I’m expecting an article soon suggesting we put up trade barriers. You seem to forget the financial sector is not the economy, it is part of the economy. If the financial sector fails to contribute towards meeting humanities needs, that is aid the production of goods and services we use and need… Read more »
Hd
Guest

F**k charles thats it thats the feeling I had that you have just put into a thought for me! Ahhh I feel much better now, are you in agreement or that this comment would be correct…

That the system because so many rely on it has to balance itself?

John
Guest
charles you’re so deeply misguided I don’t know where to begin. When you buy gold it doesn’t take money out of the money supply (aka cut off capital), it simply transfers the money from you to somebody else (the seller of the gold). Before you buy the gold, you have dollars and they have gold. When you buy the gold, you’re left holding an asset and they’re left holding paper with dead people on it. You’re betting that the government will print more paper, thus making the paper worth less in terms of your asset (gold), or in other words… Read more »
charles
Guest

John

Yes buying gold doesn’t create the stuff, and handing over the paper with dead people on it doesn’t destroy the paper; however capitalist fearful of their own shadows removes their value. If the capitalists aren’t willing to take on future risks then someone else has to, and the capitalists should stop whining when they get cut out.

Ademac
Guest

John,

What about the poor gold miners?? If we don’t buy gold then they wont have a job :P for me its about job creation.

Ademac

Coffee Addict
Guest

I’ve just bought some upstream Vic gold shares with a very reasonable prospect of long term viable production. Still risky YES still speculative YES and high environmental compliance costs YES but so what! The potential upside is significantly greater than the potential downside of a very small outlay assuming a 50/50 chance of successful production being realised.

Back to what Charles was saying YES gold is just a commodity but it is an inceasingly popular one in the emerging economies.

James
Guest
Like John said “charles you’re so deeply misguided I don’t know where to begin.” Taking a few lines from your comment: “methods used to unwind the great depression” – was world war 2; a couple of the “methods” used to unwind the great depression were limiting work hours (in the name of protecting price pay for labour) and burning produces (in the name of protecting farm gate prices). When the war came they were forced to stop “helping”, as a result the reduced and less experienced workforce (mainly women with many never having worked in factories before) in America producing… Read more »
John
Guest
“capitalists fearful of their own shadows”? Really, Charles? Really?!? The only thing us “capitalists” fear is the government, along with their printing presses! That’s why we buy gold! Yes if enough people switch to gold from dollars, it devalues the dollar. But it also increases the value of gold! There was no wealth created or destroyed (you seem to be implying the latter). There was simply a shift in the medium of exchange between items of real value (which, again, didn’t lose or gain any value during this process). Buying gold doesn’t hurt the economy, no matter what the Bernankes… Read more »
charles
Guest
John you seem to worship gold, there has been two other periods of inflation in the last 1000 years, both occurred when the trading currency was underwritten by gold; Spanish loot the New World and the Black death. In the first cases it was over supply, in the second a lack of demand. The people holding the gold had the same problem you do with paper, they could buy less goods. I no more care about the price of gold than I do about the price of frying pans (read Adam Smith), I care about goods and services. And yes… Read more »
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