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Monday, September 15, 2008

The Rise and Fall of Fannie Mae and Freddie Mac

As the American financial system is shaking from major companies going under or being bought for dimes on the dollar, the public deserves to know "what went wrong?"

Fannie Mae and Freddie Mac were hedge funds that privatized profits and socialized risk, something I thought was only possible with corrupt regulators and third-world countries.

Fannie Mae and Freddie Mac had the closest thing to a license to print money. They legally borrowed money at below-market interest rates based on the perception that the government guaranteed repayment, and then they used the money to buy mortgages that paid market interest rates.

Way back in 1996, the Congressional Budget Office reported that Fannie and Freddie were using government support to increase their profits, rather than reducing mortgage rates to make homes more affordable, the reason for their existence. The budget office study found that these "profits" were worth $3.9 billion in 1995. By 2004, these profits jumped to $20 billion. These were profits meant to make housing more affordable, not make Freddie and Fannie insiders rich while paying to get their supporters reelected.

This article from the Washington Post details it well.

How Washington Failed to Rein In Fannie, Freddie
Excerpts from the article:
Gary Gensler, an undersecretary of the Treasury, went to Capitol Hill in March 2000 to testify in favor of a bill everyone knew would fail.

Fannie Mae and Freddie Mac were ascendant, giants of the mortgage finance business and key players in the Clinton administration's drive to expand homeownership. But Gensler and other Treasury officials feared the companies had grown so large that, if they stumbled, the damage to the U.S. economy could be staggering. Few officials had ever publicly criticized Fannie Mae and Freddie Mac, but Gensler concluded it was time to urge Congress to rein them in.

"We thought this was a hand-on-the Bible moment," he recalled.

The bill failed.

Blessed with the advantages of a government agency and a private company at the same time, Fannie Mae and Freddie Mac used their windfall profits to co-opt the politicians who were supposed to control them. The companies fought successfully against increased regulation by cultivating their friends and hounding their enemies.
The rest of the article gives a great history of the rise and fall of Fannie and Freddie.

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My blood pressure boils and I feel like spitting at my TV whenever I see Barnie Frank speaking. Long before I learned of his support of the GSEs, I felt he evaded direct answers to questions with a Libertarian slant that questioned his Socialist leaning beliefs.
In October 1992, a brief debate unfolded on the floor of the House of Representatives over a bill to create a new regulator for Fannie Mae and Freddie Mac. On one side stood Jim Leach, an Iowa Republican concerned that Congress was "hamstringing" this new regulator at the behest of the companies.

He warned that the two companies were changing "from being agencies of the public at large to money machines for the stockholding few."

On the other side stood Barney Frank, a Massachusetts Democrat who said the companies served a public purpose. They were in the business of lowering the price of mortgage loans.
Barney Frank should get a ride to a federal prisoin in tar and feathers on a rail.
In the fall of 1999, Treasury Secretary Lawrence Summers issued a warning, saying, "Debates about systemic risk should also now include government-sponsored enterprises, which are large and growing rapidly."

It was a signal moment. An administration official had said in public that Fannie Mae and Freddie Mac could be a hazard.
We were warned but those we elect to protect us with regulations appear to have been bought and paid for to look the other way.

People talk about how good the economy was during the Clinton presidency, but it now seems the good times were from building BOTH the internet/telecom bubble that collapsed in 2000 and the housing bubble that started its collapse in 2006.

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Beware of Annuities

September 18, 2008 update:

It will be VERY tough to Blame President Bush according to this New York Times article that shows the president tried to do something five years ago.
September 11, 2003
New Agency Proposed to Oversee Freddie Mac and Fannie Mae

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.
It looks like president Bush is far smarter than his critics give him credit for. His lack of skill is in getting the good stuff accomplished.

Kirk Lindstrom's Investment Letter Performance

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