The New Fannie Mae

I’ve read the announcements. I’ve gone though what’s been written over the last 2 days. I’ve studied the history of Fannie Mae. What’s happened this weekend is that Fannie has gone full circle. Fannie originally was a government program created to create liquidity in the mortgage market. No different than what the government is looking to achieve today. (Freddie Mac was created in 1970 for the sole purpose of creating a competitor to Fannie Mae. It’s nothing more than Fannie Mae’s younger sibling.)

Fannie Mae was chartered in 1938. The impetus for creation of Fannie Mae was twofold: the national commitment to housing and the inability or unwillingness of private lenders to ensure a reliable supply of mortgage credit throughout the country. The primary purpose of Fannie Mae was to purchase, hold, or sell FHA-insured mortgage loans that had been originated by private lenders. In 1968 Fannie Mae was split into two parts: Ginnie Mae and a reconstituted Fannie Mae. Ginnie Mae would continue as a federal agency and be responsible for the then-existing special assistance programs, and Fannie Mae would be transformed into a "government-sponsored private corporation" responsible for the self-supporting secondary market operations. The reconstituted Fannie Mae was to be stockholder-owned and managed.

In the Sunday, September 7, 2008 edition of The New York Times a staff writer identified the obvious flaw in the creation of Fannie Mae. The government mandate to Fannie Mae required it to serve 2 masters, a situation that is designed for failure. As a private company it was suppose to put the shareholders’ interests above all else and as a government agency it was required to assist first time homebuyers, maintain liquidity in the mortgage market and time keep the cost of mortgages down.

Things were moving along fine until the same greed and corruption that ripped through Wall Street and the banks got into the GSEs. Could it have been avoided? Should we have seen it coming? It doesn’t matter now; we’re already in trouble.

The government had the right to take over the GSEs under their original charter going back to 1968. The recently enacted emergency housing bill gave the Treasury to ability to invest in the GSEs though various avenues. This was an excellent gambit by Treasury Secretary, Paulson. If having the authority to buy into Fannie created stability in the marketplace, great. If it didn’t work, don’t use the additional freedom to invest and move directly to the takeover. Taking this path the government now has full managerial control. We are already seeing the first positive steps, a new chairman has been brought in, dividends have stopped being paid to shareholders and the lobbying budget has been eliminated.

I have been promoting that way out of this mortgage mess we’re currently in was for the government to become the secondary market. They could create an agency in the mirror of Ginnie Mae. But instead of securitizing government mortgage loans it would be in the business of securitizing mortgages issued by private industry. This would slowly recreate a secondary market. This is exactly what’s happening here. But instead of creating a new agency they are taking over the GSEs (Fannie Mae & Freddie Mac). The infrastructure needed to package mortgages and then issue mortgage backed securities is already in place. The existing systems will now be working for the government instead of for the shareholders.

Although the media is calling this a bailout of the GSEs, it really isn’t. Current shareholders have lost their dividend payments and the stock they’re holding is worthless. It’s only after the Fannie Mae and Freddie Mac reimburse, with 10% interest, any capital invested and the government decides not to exercise their option to purchase 80% of the stock of the GSEs at a price of $1.00 a share will the existing shares have any market value.

It’s my opinion that unless the government totally screws thing up, this will turn out to be a profit center for Washington. Washington will then have the option to keep Fannie and Freddie under direct government control, turn then back into private enterprises or break them up into smaller more manageable private entities.

This is the beginning of the end of the housing crisis.