Debate Is Buzzing Over Whether Fannie and Freddie Are Ready To Be Released From Conservatorship

The arrival of the new Trump Administration is reviving debates about releasing Fannie Mae and Freddie Mac from the conservatorship and government control that came with their bailout by the Treasury in 2008. What should happen next is a major financial system issue, since Fannie and Freddie are giant firms, with combined assets of more than $7.7 trillion.The most important factor in the “release” decision is seldom mentioned: Should the future Fannie and Freddie, as in their pre-bailout past, get a free government guarantee of all their obligations, now totaling $7.5 trillion? In other words, should Fannie and Freddie’s shareholders get a taxpayer subsidy of billions of dollars a year? The answer is that this costly mistake of the past should not be repeated.Fannie started life in 1938 as a straightforward part of the government. Its debt was government debt and any profits it made accrued ultimately to the Treasury. In a strategic blunder in government finance, Fannie was in 1968 turned into a “government-sponsored enterprise” to achieve a bookkeeping result: To get its debt off the government’s books as President Lyndon Johnson’s deficits ballooned. A government-sponsored enterprise is a corporation with private shareholders but also a free government guarantee of its debt. This guarantee is only “implicit,” it was always said, but it is fully real, as demonstrated by the 2008 bailout that fully protected all creditors, even subordinated debt holders. Creditors of GSEs are always saved by the government.The financial essence of a GSE is that the huge value of the free government guarantee is a gift to the private shareholders. Freddie joined Fannie as another GSE in 1971. The two became in time an exceptionally profitable dominating duopoly, since no private firm can compete with the free guarantee of a GSE. They both, but especially Fannie, developed remarkable arrogance and Fannie was widely feared for its bully-boy tactics. As the Book of Proverbs tells us, “Pride goeth before destruction and a haughty spirit before a fall.” As the housing bubble collapsed in 2008, Fannie and Freddie had their fall, having invested excessively in bad loans. Then came their bailout and government conservatorship. From being GSEs, they were turned into “GOGCEs”: Government-Owned and Government-Controlled Enterprises. That is what they remain at present, not GSEs.This has meant their government guarantee is no longer free, because in effect, they pay for it as part of giving the Treasury all their net profits in the form of increased value of the Treasury’s bailout senior preferred stock. The value of the Treasury’s preferred stock in Fannie and Freddie is now up to $334 billion from its original $190 billion. In addition, the Treasury owns warrants with the right to acquire at the exercise price of one-thousandth of a cent per share new common shares of Fannie and Freddie giving Treasury a 79.9 percent ownership of the common. Why 79.9 percent? Bookkeeping again. At 80 percent, the government would have to consolidate Fannie and Freddie’s debt on its books.These warrants expire in September 2028 — during the term of the current Trump administration. This creates a Treasury duty to do something before they expire. For example, Treasury could exercise its warrants, which has virtually no cost, and simply hold the new shares.Some people, though, view this expiration date as an incentive to free Fannie and Freddie from their long conservatorship by what they claim would be a “privatization.” Yet it would not be a privatization, and Fannie and Freddie would not be private companies if they once again got a free government guarantee. Such a deal would simply be turning them back into GSEs, with the value of the government guarantee as a gift to the private shareholders. One can easily see why the private shareholders of Fannie and Freddie like this idea and why the taxpayers should not.In any proposed exit from conservatorship, Fannie and Freddie should pay a fair price to the Treasury for the government guarantee that makes their business possible. Setting that price would involve spirited discussions. Based on the model of deposit insurance for the largest banks, a fair price should be assessed on Fannie and Freddie’s total liabilities and might be about 8 basis points, 0.08 percent, a year.That would now cost Fannie and Freddie about $6 billion a year — not expensive at all for what allows their trillions in obligations to be easily sold and traded all over the world, no matter how risky Fannie and Freddie themselves may be. The essential principle is that Fannie and Freddie should never again get a free government guarantee.

Debate Is Buzzing Over Whether Fannie and Freddie Are Ready To Be Released From Conservatorship

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