Fannie & Freddie – A Model “Broken Beyond Repair”

Posted on by Phil Querin


According to a 2009 Vanity Fair article, in the 1980s Fannie Mae was “…one of  the largest, most profitable companies in the world, with a stock-market value of more than  $70 billion…*** (By comparison, G.M. at its peak, in 2000, was worth only $56 billion.)”   Today Fannie’s share price is around 29¢, with a market cap of $359.5 million.

For the last ten years, both giant Government Sponsored Enterprises (“GSEs”), Fannie and Freddie, have seen their fortunes turn to dust.  In 2003, it was learned  that Freddie had misstated its earnings by $5 billion between 2000 and 2003. It was fined $175 million by the Office of Federal Housing Enterprise Oversight (“OFHEO”), an independent HUD regulator.  Next it was Fannie’s turn.  OFHEO also investigated Fannie Mae and reported that:

  • Between ” … 1998 to mid-2004, Fannie Mae reported extremely smooth profit growth … those achievements were illusions deliberately and systematically created by the Enterprise’s senior management with the aid of inappropriate accounting and improper earnings management.[1]
  • (T)he Enterprise also had serious problems of internal control, financial reporting, and corporate governance.
  • Fannie Mae engaged in excessive risk-taking, which included increased holdings of subprime and Alt-A private-label MBS and the use of derivatives to manage the interest-rate risk of GSE investment portfolios.
  • Those errors resulted in Fannie Mae overstating reported income and capital by an estimated $10.6 billion.”

Fannie Mae paid a $400 million civil penalty and the Securities and Exchange Commission required that it restate its financial performance for 2002 through mid-2004.  Between that embarrassment and the forced departure of its CEO, Franklin Raines, and its CFO, Timothy Howard, Wall Street bailed, and its share price plummeted, reducing its market cap by tens of billions of dollars.

As the country reeled from what was initially referred to as the “Subprime Lending Crisis” – which we now know was not limited to just subprime loans – in an effort to restore confidence in housing, investor confidence in the credit markets and GSEs [which by then were circling the drain – PCQ], Congress enacted the Housing and Economic Recovery Act in July 2008.  In September 2008, the FHFA placed Fannie and Freddie in to conservatorship, where they remain today.  But together, the GSEs are  reminiscent of the zombies from Night of the Living Dead; they just refuse to die.

On March 28, 2012, the Office of Inspector General (“OIG”) issued a “White Paper” entitled “Assessment on FHFA’s Conservatorships of Fannie Mae and Freddie Mac. “

This White Paper should have been entitled “Obituary.”  There is something slightly macabre about two organizations on life support whose primary missions are to make their own funeral arrangements.  In the words of the OIG:

“…the conservatorships have been in place for over three years, and there is no end in sight. FHFA estimates that, by the end of 2014, between $220 and $311 billion in financial support will have been drawn from the Treasury, and FHFA’s Acting Director has stated that taxpayers are unlikely to be fully repaid for their support.”

The fact that Congress and the Acting[2] Director of the FHFA, Edward DeMarco, cannot even agree upon FHFA’s mission, does not bode well for the future of the GSEs.  Meanwhile, they have consumed 183 billion taxpayer dollars, as the Administration and Congress dither on what a secondary mortgage market structure should look like.

Citing the White Paper: “…a conservator’s goal is to continue the operations of a regulated entity, rehabilitate it and return it to a safe, sound and solvent condition….”  That doesn’t look like it will ever happen.  Yet, if no one pulls the plug, we could have Fannie and Freddie lingering on tax payer subsidized life support for decades.

Even Acting Director Mr. DeMarco is not optimistic, “[T]he Enterprises will not be able to earn their way back to a condition that allows them to emerge from conservatorship. In any event, the model on which they were built is broken beyond repair.”

OK, we get it.  We’ve watched this soap opera play out for ten years. It’s time to stop writing white papers and holding hearings.  Perhaps after the election, congressional leaders will grow spines and figure out a way to have a secondary market that works without taxpayer support.

[1] The reason for the “extremely smooth profit growth” was, according to the OFHEO, to mask “…their volatility *** giving the Enterprises the appearance of low-risk companies.” Its predictable earnings made Fannie a Wall Street darling. By achieving its predetermined financial goals, senior management was able to regularly hit bonus projections.  This isn’t to say Fannie lied about the money it was actually making.  Rather, what it did was secretly set aside profits for periods of slower revenue, thus making it appear as a smooth running machine, when it wasn’t.  This practice of concealing monies for later accounting periods became known as “Cookie Jar Accounting.”

[2] He is serving in this temporary capacity, since there is no agreement to confirm him for the permanent position.


Posted in Fannie&Freddie, Financial Crisis, Foreclosure, GSEs, Legislation - Federal, Lenders, Market Conditions, Miscellany, Real Estate/Distressed | Tagged , , , ,
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