and, as one of four Oversight Board members who control the FHFA, the U.S. Treasury also represented the other side. It is also of interest to note that a second member of the 4 person Board is the Securities and Exchange Commission whose responsibility, in theory, is to protect the rights of shareholders – i.e., the holders of Fannie Mae and Freddie Mac preferred and common stocks.
It is not my purpose to go into the arguments of the two sides in these cases. The transcripts of the two sides’ arguments are available from the applicable courts. My opinion, however, is clear. I think that the U.S. Treasury broke the law and will lose these cases.
However, I also think that the law breaking was so egregious that the U.S. Treasury will never allow these cases to go to court. The discovery in these cases is likely to be so damaging to the United States government that, if made public, it will lead to outcries from anyone who believes as I do that this government is committed to the rule of law.
This means that there will be a negotiated settlement, which in my view will reverse the Third Amendment by a simple statement of the Secretary of the U.S. Treasury. I have argued for years that the U.S. government has acted as if there were no laws protecting the shareholders of banks. This is one of the most outrageous examples but by no means the worst or only one.
Fannie Mae, Freddie Mac’s Conflicts
It is difficult for me to see how legislation can be passed related to Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) until these court issues are resolved. I think that the comments of Senator Crapo in his TV interviews are suggesting the same.
However, a second issue that I have been writing about for years is that the regulatory establishment for the banking industry in this country is absurd. It is a “Rube Goldberg” contraption that does not work. It failed to protect Americans from the excesses in banking and housing prior to the financial crisis. It is now building massive risk into the financial system by over regulating the banks and stimulating the growth of unregulated non-bank financial companies.
This is not a point I want to pursue here, however. What I wish to point out is that the actions of one part of this Rube Goldberg regulatory contraption are often in total conflict with the actions of other parts. The statements concerning the, yet to be released, Johnson/Crapo Bill are a perfect example of this.
Fannie Mae, Freddie Mac: Liquidity
The expected Liquidity Coverage Ratio rules contain the following incentives:
- Banks obtain higher ratios if they dump GSE mortgage backed securities and replace them with cash, Treasuries or Ginnie Mae’s.
- Banks are penalized if they shift from government guaranteed mortgage backed securities to privately insured mortgage backed securities.
- We are told Johnson/Crapo has as one of its core tenets that the private sector will replace the government in insuring mortgage backed securities. This is a pure conflict with banking regulation.
Fannie Mae, Freddie Mac: Incentive
Staying with the thought that Johnson/Crapo will emphasize the private sector replacing the government in the mortgage finance business one comes up against this contradiction. Johnson/Crapo eliminates 100% of the private investments made in Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). It destroys all equity capital. It then suggests that these same investors who have just had their equity investments in housing finance wiped out by the government are going to line up for a new government scheme in housing finance.
Low Income Housing
There are numerous government regulations from Basel III and its risk weighting system to the Consumer Financial Protection Bureau’s (CFPB) Qualified Mortgage rules to the proposed Supplementary Leverage Ratio which clearly heavily penalize banks if they make loans to low income households to buy houses. The rules and regulations are so draconian that a number of banks have indicated to me that they cannot make money originating these or, for that fact, qualified mortgages. This is causing the flow of funds to the housing industry to meet with meaningful obstacles.
One core product in attempting to maintain low income housing is the 30-year fixed rate mortgage. Yet, I cannot find one bank that I know of that is willing to make these loans and hold them on its books. These loans must be sold to Fannie Mae or Freddie Mac if they are to continue to exist. Yet Johnson/Crapo wants to eliminate Fannie Mae and Freddie Mac.
The backers of Johnson/Crapo claim that they have some mechanism that would protect the continued existence of the 30-year mortgage. They claim that they have a mechanism that would offset the massive regulations that prevent low income housing from being funded. I do not know as yet what they are but there are a number of regulations that must be changed to allow both 30-year loans and low income housing loans to exist.
If those members of Congress who fill the halls of that institution with its heating supply, through their speech making in support of the poor, actually want to do something for the poor, and stop voting for bills that harm the poor, they would vote against Johnson/Crapo. I think that if they are to maintain any credibility they will.
Fannie Mae, Freddie Mac: Bail-Out
If there is anything that the Congress and press love it is to argue that the financial system of the United States was bailed out by the American people. What they never mention is that without the investments made in the financial system the economy would have collapsed so that the American people were bailing out themselves. Also never mentioned is that the taxpayer made a significant profit in the investments made in the financial system. The greatest of these profits was made in Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC).
These entities took down a little over $187 billion in investment from the U.S. Treasury. The return on this investment has been:
- A payback of $203 billion.
- The creation of the Preferred A which is now valued at $190 billion and should be paying $19 billion a year in dividends in perpetuity.
- The ownership of warrants to buy 8.2 billion shares of these two companies at $0.00001 per share each, valued at $33 billion. The common shares would also be paying a dividend if the U.S. Treasury so allowed.
In the greatest theft ever of the American taxpayer ever, Johnson/Crapo would eliminate Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and wipe out in total the value of the preferred and the common. Plus, it would rob the taxpayers of the dividends mandated on the preferred and hoped for on the common.
Fannie Mae, Freddie Mac: What Should Be Done
All logic argues that the U.S. Treasury should unilaterally take the following steps:
- End the conservatorship and set Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) back as private sector owned organizations.
- Nullify the Third Amendment returning the Preferred A to its initial status.
- Donate the Preferred A and the warrants to a new organization devoted to supporting low income housing (which I would love to call the Bove Plan despite stealing the idea from others).
- Do everything possible to support the health and profitability of Fannie Mae and Freddie Mac since the taxpayers own 80% of these companies.
- Incent the private sector holders to make as much money as possible so that they will be incented to aid the government in aiding housing.
If Johnson/Crapo were ever to be successful, the result would be a weak housing market and a weaker economy. It will fail. The U.S. Treasury will lose its case in my view and Fannie Mae and Freddie Mac will be set free.
