Can We Avoid A GSE Bailout?


BLOG VIEW: Although much time and attention in Washington, D.C., has been devoted to healthcare and the budget during the past few months, another huge issue looms ahead: the fate of Fannie Mae and Freddie Mac.

The government-sponsored enterprises (GSEs) were supposed to represent a public-private partnership. Exempt from state taxes and SEC regulations, the companies also enjoyed a cozy relationship with the federal government, including having access to separate $2.5 billion lines of credit with the U.S. Treasury.

Those lines of credit were taken as a hint that the government would step in if Fannie Mae or Freddie Mac ever faced real financial trouble – a perception that allowed them to borrow at lower rates than private firms purchasing mortgages in the secondary market.

The arrangement worked remarkably well until 2008, when the financial crisis struck. While other investors exited the market, Fannie Mae and Freddie Mac kept buying mortgages, in essence, maintaining the national secondary market. They did this so well and bought so many mortgages that James. B. Lockhart, director of the Office of Federal Housing Enterprise Oversight (OFHEO), the companies’ regulator, issued a statement in July 2008 reassuring everyone that Fannie and Freddie were “adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums. They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.”

A few weeks later, both companies were placed into conservatorship by the U.S. government.

Now, nearly a decade later, the big question is what happens next. Does Uncle Sam keep Fannie and Freddie in conservatorship, return them to the private sector or shut them down? Or, is it possible that the GSEs could fail and bring down the mortgage marketplace with them?


According to ProPublica, Fannie Mae received $116.149 billion in preferred stock investments from the Treasury, while Freddie Mac was given $71.336 billion – a total of $187.5 billion.

“The money advanced to Fannie Mae and Freddie Mac was part of the overall Wall Street bailout,” says Rick Sharga, executive vice president at, an online real estate marketplace. “However, if you look at the returns Uncle Sam got for his money, it’s clear that the GSE investments performed especially well.”

As SeekingAlpha explains, “The $68.3 billion net profits of Fannie Mae and Freddie Mac accounts for 61.2 percent of the overall net profit brought in by 610 companies; it is 90.1 percent of the total net profit ($75.81 billion) when the losses from 335 companies ($35.81 billion) are accounted for. Thus, the total net profit would only be $7.51 billion (~10x less) without the GSEs’ profits!”

Such results raise several questions. Was it necessary to nationalize Fannie Mae and Freddie Mac? What happened to the investments of private shareholders in the two companies? If the government continues to pull all profits out of the GSEs, could they fail?

The takeover

“The FHFA was established to ensure that Fannie Mae, Freddie Mac and the Federal Home Loan Banks operate in a safe and sound manner,” says Lockhart, director of the Federal Housing Finance Agency (FHFA), on Sept. 4, 2008, just weeks after his July statement declaring that the two giants had more than $1.5 trillion in unpledged assets. “We are working quickly to set up the regulatory framework needed to make certain that their operations and activities foster liquid, efficient, competitive and resilient national housing finance markets.”

There are several problems here.

First, the marketplace was dominated by the private sector prior to the mortgage meltdown, not Fannie Mae and Freddie Mac. In the era of option adjustable-rate mortgages, no-doc loan applications and massive prepayment penalties, 67% of all mortgages were originated by the private sector, according to Jim Glassman, a noted conservative business author.

Second, it was not at all clear that either company faced any financial emergency, given their vast resources, as well as the fact that neither halted daily operations.

In the second quarter of 2008 – just before the takeover – Fannie Mae reported a $2.3 billion net loss. But did the company really lose a lot of money, given its size? Did it lose any money at all?

The reason to ask is that companies can manipulate their financial results by raising or lowering the amounts they set aside for loan loss reserves. In the case of Fannie Mae, for example, it’s not certain that it had an actual second-quarter loss in 2008.

You “must add back the non-cash loan loss reserve of $5.5 billion,” explains Adam Spittler and Mike Ciklin. “After this adjustment, Fannie Mae shows a cash net income figured of $3.2 billion. You are reading this correctly. Fannie Mae generated roughly $3.2 billion in cash in the second quarter of 2008, the quarter just before conservatorship. This is poor evidence of a ‘failing business model.’”

“In 2013 and 2014,” notes Spittler and Ciklin, “these reserves were reversed as unnecessary in the first place, showing massive net income to the entity.”

Third, the takeover of Fannie Mae and Freddie Mac produced enormous damage to small banks. Under the federal rules at the time, community banks could hold preferred stock in the GSEs, and the value of those shares would count toward their capital base. When the value of Fannie Mae and Freddie Mac shares plummeted because of the federal takeover, so did the capital of many smaller banks, forcing them to either recapitalize in a bad market or fold.

According to the Independent Community Bankers of America, “The Treasury Department’s Sept. 7, 2008, action to place Fannie Mae and Freddie Mac into conservatorship was done in a way that effectively wiped out the value of Fannie Mae and Freddie Mac preferred stock held by community banks. The estimated value of these community banks’ preferred holdings was $16 billion. In many cases, regulatory examiners and outside accounting firms encouraged community banks to purchase GSE preferred stock as a good, low-risk asset for diversification. Affected community banks were forced to write down the preferred shares, taking a huge hit to their capital, resulting in reduced lending capacity.”

Fourth, rather than massive losses, it turns out that Fannie Mae and Freddie Mac produced enormous revenues. Not only have they fully paid back the money advanced by the Treasury, but they have also sent an extra $63.8 billion to the Treasury – a sum not to be overlooked.

In addition to profits, money was generated for the government by the GSEs under the Temporary Payroll Tax Cut Continuation Act of 2011. With this legislation, Congress required Fannie Mae and Freddie Mac to charge an additional 10 basis points for loan guarantees during part of 2012. The money collected did not go to benefit housing or borrowers; it went into government coffers. The money collected was simply a tax, a way to offset the deficit.

Fifth, once the federal government took over Fannie Mae and Freddie Mac, it owned warrants equal to 79.9% of the outstanding shares for both companies. With warrants, the government did not actually own shares, but it “could” own shares if it wanted. Through the conservatorship, it also controlled the management of the companies.

In 2012, the government amended the bailout agreement with a “sweep.” From this point forward, the Treasury would get 100% of all GSE profits. This was an agreement negotiated between one part of the government (the part that directly controlled Fannie Mae and Freddie Mac) and another part of the government (the Treasury).

At this point, the government continues to get all of the profits generated by the GSEs – $5.5 billion from Fannie Mae in the fourth quarter of 2016 and $4.5 billion from Freddie Mac during the same period, which is a nice quarterly total of $10 billion.

Not surprisingly, shareholders are suing, claiming the government’s actions are a gross violation of the U.S. Constitution’s “taking clause,” which prohibits the seizure of private property without just compensation. Shareholders also argue that by removing all profits, the company is being devalued because of a lack of retained earnings. Without retained earnings, the worry is that the companies will shrink and can actually fail, somehow turning massive cash cows into financial cadavers.

At this writing, the matter is in court, and there’s no way to know how the final ruling will turn out.

What happens next is unclear, considering the following:

Proposals to replace Fannie Mae and Freddie Mac with new firms will falter unless Congress okays a federal line of credit – something it has been unwilling to do.

If the government loses the GSE shareholder suit, it could be on the hook for tens of billions of dollars. If this seems unlikely, it’s good to remember that the government lost the 1996 Winstar case, a case that claimed the government had changed regulatory rules in a way that unfairly forced the closure of many savings and loan associations. Damages from this case exceeded $20 billion.

Meanwhile, day in and day out, Fannie Mae and Freddie Mac are buying local loans and generating huge profits. The GSEs work – and if left alone, they will not need a federal bailout.

But being left alone seems to be the one option not on the table.

Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at and contributes to such leading sites as, the Huffington Post and Ten-X. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.

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