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Fannie and Freddie vs. Joe Taxpayer

July 21, 2008

by Ivan Raconteur

Some people have been critical of our elected officials, and have unkindly suggested that they are either confused individuals who couldn’t find sand in a desert, or slick operators whose chief goals are to line their own pockets and promote their own special interests.

To be fair, though, we should acknowledge that there are some things that government is very good at. To wit, no one is more skilled at making simple things complicated or creating special entities that defy both normal rules and common sense.

Some of these entities even have a special name. They are called government sponsored enterprises (or GSEs).

The government could give us a long and complicated explanation of what they are and why we need these enterprises, but the short version is that they are a handy way for a few people to make a lot of money at the expense many, under the protection of some special rules that apply only to them.

Fannie Mae and Freddie Mac are among these GSEs.

They were set up with the noble goal of making mortgages available to the masses, and they have been quite successful in this.

They either own or guarantee about half of all of the mortgages in this country.

Some might think this is an awful lot of eggs to put in just two baskets.

The problem is, when companies get that big, it is very easy for the government to claim “it has no choice” but to lend a helping hand when things go awry, on the grounds that if the companies are allowed to fail, it would create an even bigger financial mess both in this country and around the world.

Government officials have claimed for years that the trillions of dollars in debt issued by the companies is not guaranteed, but proposals announced last week suggest that the government is falling all over itself trying to help them out.

The Bush administration asked Congress to fork over billions of dollars to the companies in the form of loans or investments.

One way the administration hopes to do this is by increasing their credit line to $300 billion.

They really like big numbers in Washington.

Treasury Secretary Henry Paulson also asked for authority to make unlimited equity investments in the companies if this becomes necessary. This means that if the stocks really tank, the government wants to step in and buy as much of the worthless stock as possible.

Not to be outdone, the Federal Reserve jumped in and said it would allow the companies to take advantage of a short-term lending program at favorable rates.

The actions were taken in response to growing concern about the financial stability of the companies.

Their stock prices have been plummeting faster than the nighttime temperature in International Falls in January.

While the politicians try to paint the companies as lily white benefactors whose sole mission is to make housing accessible for the masses, we should bear in mind that their records don’t support this.

Last April, former Fannie Mae chief Franklin Raines and two other company executives agreed to cough up $31 million in a settlement that resulted from their roles in a 2004 scandal.

One report indicated that about $84 million of the $91 million in compensation that Raines raked in between 1998 and 2003 was tied to faulty accounting.

A 2006 lawsuit brought by the Office of Federal Housing and Enterprise Oversight (OFHEO) suggested that the companies engaged in creative accounting practices to net more than $115 million in bonus payments.

In May 2006, Fannie Mae agreed to pay $400 million in civil penalties related to charges brought by OFHEO and the Securities and Exchange Commission.

Some say the companies have helped to lower housing costs and interest rates for home buyers, but it appears that they have also done quite well for company executives and fat cat investors.

One can’t help but be suspicious of any entity that is considered private when it comes to earnings, but becomes semi-public when it comes to losses.

Without getting into a debate about whether government should be involved in the mortgage business in the first place, it seems that if taxpayers are going to be exposed to risk when things go badly, they should also be allowed to participate in profits when things are going well.

One might also question why it is necessary to pay the monkeys at the top of the pile such an exorbitant salary, not to mention the obscene six-figure bonuses that seem to be the norm at these companies.

The average salary for a person with an bachelor’s degree was less than $52,000 in 2004, and the average salary of those with advanced degrees was just over $78,000.

If the goal is to make housing available to more people, and deliver a profit to shareholders, one would think there must be plenty of bright and capable people out there who would do the job for far less money.

Most Americans are facing difficult economic times, and we don’t need the threat of exposure to trillions of dollars in additional debt hanging over us.

It is possible that even if Congress approves the measures proposed last week, no tax dollars will be needed to stabilize Fannie and Freddy. It makes one a bit uncomfortable, though, when government officials ask for carte blanche to support a rocky institution with unlimited loans or stock purchases.

No doubt the government is sincere when it says it doesn’t expect to ever have to use these options, but one can’t avoid a certain sense of uneasiness any time government officials ask us to blindly trust them.

It seems that when the government says “trust me,” Joe Taxpayer is the one who gets left holding the bag.