WASHINGTON – Freddie Mac is asking for $10.6 billion in additional federal aid after posting a big loss in the first three months of the year. It's another sign that the taxpayer bill for stabilizing the housing market will keep mounting.
The McLean, Va.-based mortgage finance company has been effectively owned by the government after nearly collapsing in September 2008. The new request will bring the total tab for rescuing Freddie Mac to $61.3 billion.
Erza Klein posits:
The problem is that Fannie and Freddie are not a direct and simple subsidy for the banks. They are private companies with a government charter. Rather than using taxpayer dollars to subsidize mortgages, they were borrowing money very cheaply because their quasi-governmental status assured the market that there'd be a taxpayer bailout in the case of any sort of collapse. That is to say, their business model relied on markets ignoring the risk of their activities. And then, because they were private companies with shareholders to please, they also got into slicing and dicing mortgage packages to make money like an investment bank rather than a housing policy. In theory this should've worried the markets where they borrowed their money, but again, the government backstop saved them. Forget too-big-to-fail. This was not-allowed-to-fail.
So, of course, they failed. As Raj Date of the Cambridge Winter Center put it to me, "anytime the debt markets aren't paying attention to your risk profile, you're doomed."
Their failure was not, as some would have it, the cause of the mortgage crisis, or even close. For one thing, only about 2 percent of their portfolio was subprime. For another, they didn't start backstopping the subprime market till long after it had taken off. And for a third, their greatest losses actually were in non-subprime loans.
But they were part of the problem. And the fundamental mismatch between their risk and activities will continue to cause problems. But solving the Fannie and Freddie problem is more complicated than it might appear. What you're talking about, essentially, is a massive subsidy for home ownership. That is to say, a massive subsidy for the middle class. So easy as it is to talk about the failure of Fannie and Freddie, it's a lot harder to talk about their elimination, as that's talking about the removal of a popular subsidy in a fragile market.
The WSJ doesn't take the role of Fannie and Freddie as lightly in the meltdown, and has a much higher number than the AP for total loss to the taxpayer. Sens McCain, Shelby, and Gregg have introduced an amendment to deal with the 2 GSEs:
The Financial Crisis Inquiry Commission spent yesterday focusing on financial "leverage," using Bear Stearns as an example. But Fannie and Freddie were twice as leveraged as Bear, and much larger as a share of the mortgage market. Fan and Fred owned or guaranteed $5 trillion in mortgages and mortgage-backed securities when they collapsed in September 2008. Reforming the financial system without fixing Fannie and Freddie is like declaring a war on terror and ignoring al Qaeda.
Unreformed, they are sure to kill taxpayers again. Only yesterday, Freddie said it lost $8 billion in the first quarter, requested another $10.6 billion from Uncle Sam, and warned that it would need more in the future. This comes on top of the $126.9 billion that Fan and Fred had already lost through the end of 2009. The duo are by far the biggest losers of the entire financial panic—bigger than AIG, Citigroup and the rest.
From the 2008 meltdown through 2020, the toxic twins will cost taxpayers close to $380 billion, according to the Congressional Budget Office's cautious estimate. The Obama Administration won't even put the companies on budget for fear of the deficit impact, but it realizes the problem because last Christmas Eve it raised the $400 billion cap on their potential taxpayer losses to . . . infinity.
Moreover, these taxpayer losses understate the financial destruction wrought by Fan and Fred. By concealing how much they were gambling on risky subprime and Alt-A mortgages, the companies sent bogus signals on the size of these markets and distorted decision-making throughout the system. Their implicit government guarantee also let them sell mortgage-backed securities around the world, attracting capital to U.S. housing and thus turbocharging the mania.
The virtue of Mr. McCain's amendment is that it will give Senators a chance to vote on the kind of reform that Congress blocked for so long, notably with Senator Barack Obama helping the blockade. The amendment mandates that the current government conservatorship of Fan and Fred will end within 30 months. In the meantime, the companies will have to reduce their mortgage portfolios by 10% each year. If the terrible twosome can't stand on their own after conservatorship, they would then go into receivership and be liquidated.
If they can survive on their own, they would have three years before the expiration of their federal charters, during which time they would have new operating restrictions. Messrs. McCain, Shelby and Gregg would repeal the affordable housing goals previously legislated for Fan and Fred and which contributed to their terrible mortgage bets, and the companies would have to reduce the mortgage assets held on their books by nearly 50% within two years and raise their capital standards.
Fannie and Freddie would also have to start paying state and local sales taxes, lose their exemption from full registration at the Securities and Exchange Commission when they issue securities, and start paying fees to repay the taxpayer for the value of federal guarantees. The $400 billion limit on taxpayer assistance would be reinstated, and for as long as they are in federal conservatorship or receivership, they would have to be included in the federal budget.
In short, the McCain amendment precisely targets the problems that caused the mortgage crisis: If the housing giants are no longer subsidized, they will become small enough to fail. That means they will stop lending money to people who cannot afford to pay them back, and in turn they will stop endangering taxpayers.
[emphasis mine]
It's time to get the government out of the housing business. Erza wants to tackle it in a separate housing bill, arguing those reforms won't be felt in the financial market as much as the housing market. However, an astute reader points out a graph from Calculated Risk that shows just how much the GSEs subsidized the mortgage market as percentage of market share:
While I can follow Erza's logic that housing may be better dealt with via a separate bill, I have little confidence the Dems will actually break up their sacred cows. They will likely retain some type of government intervention in the housing market. Rep Barney Frank who once admitted that maybe Fannie and Freddie should be ended, sent a memo to the WH to defend the financial reform package and fight the GOP on the Fannie and Freddie narrative:
...Frank argues that Democrats have the facts on their side, and then need to do a better job of communicating them.
Freddie and Fannie have already been reformed, to some extent, by virtue of being placed into conservatorship.
“So the argument that we have ignored the need to change the operation of Fannie and Freddie in our rush to do financial reform is of course exactly backwards,” Frank wrote. “We did Fannie and Freddie first.”
Frank also wrote that the Republican proposal to abolish Freddie and Fannie would remove an important government prop to the housing market. “It is the unanimous view of every profit and nonprofit entity concerned with the housing market in the United States that simply to abolish Fannie and Freddie, as the Republicans are proposing in the House bill, and not do anything to replace the functions they are now performing with a conservatorship, would be a disaster for housing, and therefore for the economy as a whole,” Frank said.
Finally, Frank said that Freddie and Fannie are not losing money as they are currently operated – which means they aren’t making the deficit any worse.
“This is an important point that has to be repeated – as Fannie and Freddie operate today, going forward, there is no loss,” Frank wrote. “The losses are the losses that occurred before we took the first step towards reforming them – we the Democrats – and nothing we could do today will diminish those losses.”
In Wednesday’s earnings report, however, Freddie Mac said is lost $6.7 billion and was obliged to pay $1.3 billion in dividends on senior preferred stock held by the US Treasury.
“Our first quarter 2010 financial results were driven significantly by the required adoption of new accounting standards, along with continued weakness in the housing market,” said Ross J. Kari, Freddie Mac’s chief financial officer.
Frank is referring to the Rep Jeb Hensarling's bill that was introduced a few weeks ago, which the Senate amendment is modeled on. I predict Sen Reid will block the amendment from coming to the floor, and the GOP will have their ads to run in November.
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