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Jim McTague is very senior reporter. He has worked for Barrons and the American Banker. He knows his Ps and Qs.
The phrase might be "constitutional republic." No?
And one other point Ob, the GSEs worked very well for decades.
Dewey, Cheetem and Howe.
Some one has to regulate these guys. It is better for us if the FHFA remains in place. If legislation does go through all bets are off.
These are eight US Senators on the Senate Banking -- sorry that is a big deal. Hensarling is real force. And Congress is much like the weather.
Next week's action will reset the odds a little.
.20? In your scenario, SPs are dust.
No Sir. He knows how to count votes and knows the basic rules of politics. Draw your own conclusion.
Downward pressure coming: Congressman Hensarling will move on the bill Tuesday. Hensarling is a pol who knows the game.
To: Members of the Committee on Financial Services
From: Financial Services Committee Majority Staff
Date: July 18, 2013
Subject: July 23 Full Committee Markup
The Committee on Financial Services will mark up the following bill at 10:15 a.m. on
Tuesday, July 23, 2013, and subsequent days if necessary, in Room 2128 of the Rayburn
House Office Building:
? H.R. ____, the Protecting American Taxpayers and Homeowners (PATH) Act of 2013
H.R. ____, the Protecting American Taxpayers and Homeowners (PATH) Act of 2013
A bill to be introduced on July 19, the Protecting American Taxpayers and
Homeowners (PATH) Act of 2013 is designed to be a comprehensive proposal to create a
sustainable housing finance system by ending the federal government’s domination of the
housing finance market and giving consumers more choices in determining which mortgage
product best suits their needs. A Discussion Draft of the PATH Act was released by the
Committee on July 11, and a legislative hearing on the PATH Act Discussion Draft was
held on July 18.
A complete updated section by section summary of the PATH Act Discussion Draft is
attached separately.
Rock bottom prices here. Many chances ahead as well.
Always remember 7/18. That was day the tide changed.
I agree. A drift down likely. Watch the horizon. A tidal wave will be coming and we will be in for a ride of a life time - Dick Dale style. Hang 10.
Right this is why I will make some money and you will not. Congress is very divided.
That is right -their expertise is world class.
Democrats argue that a new system could be built using the best parts of Fannie and Freddie without destroying them! A bit of common sense pierces through the Congressional fog of hate and power.
Congress Takes Renewed Aim At Fannie Mae, Freddie Mac
by CHRIS ARNOLD<http://www.npr.org/people/2100196/chris-arnold>
July 18, 2013 4:00 AM
ARNOLD: Critics of the proposal, though, say it would favor the biggest banks. They might get cheaper access to money and offer better rates, and so the big banks would get even bigger and that, in turn, might mean less competition and higher costs for home buyers. Another question: Nick Retsinas, an economist at Harvard University, wonders just how much private capital will step up and for what kind of loans.
NICK RETSINAS: The issue in the shadows lurking behind all these proposals is will we have a system that preserves the 30-year fixed rate amortizable mortgage, which has been the bedrock of housing finance in the United States.
ARNOLD: In other legislation, when Republican bill would dismantle Fannie and Freddie with much less of a government backstop,another bill expected from Democrats argues that a new system could be built using the best parts of Fannie and Freddie without destroying them . Chris Arnold, NPR News
The truth is that the the GSE business model it one hell of a business model. And Fannie and Fred are staffed with the best in the nation. The leaders towards the end (pre-Sept 2008) became to focused on returns, on Wall Street and not enough on protecting capital and meeting their public mission. Let the rehab begin.
You can not reinvent an ocean.
You can not reinvent an ocean. This is the lesson of the year.
By this time next year we will have $5 stock...easily.
It is called a recess appointment...Congress has to be in recess for the President to take this action.
When the Senate schedules it. Stay tuned.
Zandi knows his stuff. And is a bellweather for the folks in DC>
Mel Watt is on the way to the post. Great news. Street rumors say that he is in soon.
Here's a great history piece. FnF will rise again!
The Fall of Fannie Mae
This is not your ordinary accounting fraud. Yes, there's the matter of $9 billion in overstated earnings. But the fight over Fannie is a nasty political showdown where everyone has his own agenda. And it's not over yet.
(FORTUNE Magazine)
By BETHANY MCLEAN
January 24, 2005
(FORTUNE Magazine) – On a sunny Monday in June 2002, President George W. Bush stood in the St. Paul AME Church in a formerly dilapidated neighborhood on the south side of Atlanta. Sitting in prime seats were Franklin Raines, the CEO of Fannie Mae, and Leland Brendsel, the CEO of Freddie Mac. The President was there to unveil an initiative aimed at helping 5.5 million minority families buy homes before the end of the decade--"Part of being a secure America," he said, "is to encourage home-ownership."
Raines and Brendsel were there because, well, encouraging home-ownership was what their congressionally chartered companies existed to do. By purchasing hundreds of billions of dollars' worth of mortgages held by banks, Fannie and its cousin Freddie made it possible for financial institutions to turn around and make more loans to prospective homeowners. Or at least that's the theory.
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Franklin Delano Raines is a prominent Democrat, but that hadn't kept him from currying favor with the new Republican President. For more than 30 years Fannie Mae has straddled two worlds--business and politics--and the company placed enormous emphasis on maintaining good relations with key government officials. In 2001, Raines had written an op-ed in the Wall Street Journal lauding Bush's faith-based initiative. He had also reached out to Bush allies in the faith-based community, including Kirbyjon Caldwell, the Houston pastor who gave the benediction at Bush's first inaugural. In October 2002, at the White House Conference on Minority Home Ownership, Raines and Caldwell were both on hand to be praised warmly by Bush for their work.
It hasn't even been three years since that sunny day in Atlanta, but oh, how the world has changed. Both Brendsel and Raines have been deposed in the wake of multibillion-dollar accounting scandals. Brendsel fell in 2003, after government regulators accused Freddie Mac of understating billions in profits in an effort to smooth earnings. More recently the Securities and Exchange Commission ruled that Fannie Mae--the larger and more important of the two companies--had violated accounting rules, overstating profits by an estimated $9 billion since 2001, which represents almost 40% of its total earnings during that period. Raines, who was paid more than $90 million during his six years as CEO--much of it linked to meeting profit targets--made a last-ditch effort to save his job, but to no avail. CFO Tim Howard was also forced out. Fannie's accounting firm of 36 years, KPMG, was fired. Once one of the most politically powerful companies in America--with staunch allies in Congress who did its bidding, a notoriously weak regulator, and a willingness to steamroller its critics--Fannie today is more vulnerable, in both a business and political sense, than it has ever been before. However it emerges from this scandal, it will almost surely never again be the unstoppable force it once was.
The Fannie story is not like other accounting scandals, though. Yes, the company broke the rules to produce a smooth stream of earnings, just as Enron, Tyco, WorldCom, and all the others did. But that's only one of a half-dozen different story lines. The Fannie Mae saga is also about a company that lost sight of its original mission. It's about power politics run amok, and the combustible blend of politics and business. It's about a company whose huge debt terrified top government officials, and whose very existence drew ideological opposition. It's about an orchestrated, behind-the-scenes campaign to rein in a financial powerhouse. It's about a regulator who learned to fight back against a much more formidable foe.
It's about all these things and one more. Fannie Mae thought itself so different, so special, and so powerful that it should never have to answer to anybody. And in this, it turned out to be very wrong.
¦THE 'BIG FAT GAP'
The Federal National Mortgage Association (Fannie) and the Federal Home Loan Mortgage Corp. (Freddie) have always been unique institutions. They are publicly held, for-profit corporations that were legislated into existence by Congress and operate with a congressional charter to help lower- and middle-income Americans buy homes. (They are often referred to as government-sponsored enterprises, or GSEs.) Fannie was founded in 1938 as a federal agency and became a for-profit company in 1968. Freddie, started in 1970, offered shares to the public in 1989.
The central idea behind the GSEs was that they would encourage home-ownership by buying mortgages from banks. This was in an era when federal law forbade interstate banking--which meant that most banks were necessarily small. When Fannie or Freddie bought a mortgage, it freed up the bank's limited capital, allowing it to make more loans. The purchase also relieved the bank of both the credit risk and the interest rate risk--that is, of having to worry that people might default, or that interest rates might rise during the life of the loan. Fannie and Freddie are one reason America is one of only two countries where lenders offer 30-year fixed rate mortgages. (Denmark is the other, by the way.)
Their congressional charters give Fannie and Freddie advantages unmatched to this day even by such giants as Citigroup and Wells Fargo. For example, the Treasury is permitted to buy $2.25 billion of each company's debt (commonly referred to as Fannie and Freddie's line of credit). Fannie and Freddie are exempt from state and local taxes and have much less stringent capital requirements than banks. Best of all, their cost of capital is only a smidgen higher than long-term Treasuries--and lower than that of even the most creditworthy companies. This last advantage, however, is not due to any regulation. Rather, it is the result of the market's belief that Fannie and Freddie's debt is safer than even AAA-rated corporate debt. Why? Because thanks to Fannie and Freddie's congressional charters, the markets believe that the U.S. government will never let them default.
In fact, there is no such federal guarantee, something Fannie and Freddie are forced to point out in their federal filings. But the two GSEs play what former assistant Treasury secretary Rick Carnell calls "a double game"--disavowing federal backing in their public boilerplate, while quietly encouraging the notion. In 1998, for instance, Fannie argued in a letter to the Office of the Comptroller of the Currency that its securities were safer than all AAA-rated debt because of the "implied government backing of Fannie Mae."
Fannie and Freddie dominate the mortgage market, but they don't originate home loans. Instead, they make their money in two major ways. One is conservative: They get a fee for guaranteeing the payments on mortgages they buy, which they then resell to investors, usually in the form of mortgage-backed securities. The more aggressive way is to hold on to the mortgages, assume all the inherent risk, and make money on the spread between their low cost of capital and the higher yield of the mortgage portfolio. (Alan Greenspan would later call this "the big, fat gap.") The more mortgages the GSEs buy, the faster their profits can grow. Since 1995, Fannie and Freddie's holdings of residential debt have grown an average of 20% a year, and together they now carry $1.5 trillion in home loans and mortgage securities on their books--more than the top ten commercial banks combined. Thanks in large part to this growth, Fannie has had double-digit profit gains for the last 17 years--and an average return on equity of 25%. But the GSEs' size has people increasingly worried about what might happen if anything went wrong--and not just to Fannie and Freddie but to the entire financial system.
There is one additional concern: derivatives, which institutions rely on to hedge interest rate risk. Over time, Fannie and Freddie became two of Wall Street's top users of derivatives. Of course, derivatives have their own risks--as America discovered in 1998 when hedge fund Long Term Capital Management blew up--and very nearly brought down the U.S. financial system with it. The idea that its activities might pose a danger infuriates Fannie Mae, which describes itself as "a bulwark of our financial system." For some of its critics, though, Fannie's refusal to acknowledge that its portfolio posed any risk would become the scariest thing of all.
¦THE BEAR IN THE CANOE
Fannie Mae has always been run by power brokers. Its CEO in the 1980s was a savvy and extremely charming man named David Maxwell. He left two legacies. First, he rebuilt the company after its one brush with death in the early 1980s, when interest rates spiked and the payments on its mortgage portfolio didn't cover the cost of its debt. Fannie survived in part because banks kept lending it money--based on the perception that the government stood behind it.
Maxwell also put in place elements of the political and business machine Fannie would become. But it was his successor, Jim Johnson, who perfected the machine. The smooth, Princeton-educated son of a Minnesota politician ran Fannie for most of the 1990s. He had worked as an advisor to Walter Mondale and was a longtime member of the Washington establishment. Indeed, last year he headed Senator John Kerry's search for a vice-presidential candidate and was rumored to be a top choice for Treasury Secretary in a Kerry administration--along with Franklin Raines.
Like both his predecessor and his successor, Johnson could speak passionately about Fannie Mae's mandate--to help create affordable housing. "The mission," he liked to say, "flows in our veins." But that idealism could be accompanied by a win-at-all-costs attitude, traits that were, and are, reflected in Fannie. A former government official remembers trying to cut a deal with Johnson by pointing out that Fannie might lose if the issue went to Congress. Johnson's reply, as the official recalls it: "There is no probability that we lose."
Despite such bravado, Johnson's essential belief was that Fannie would always be vulnerable to the whims of politicians because so few people really understood what Fannie did. "There's nothing in the home-owner's life called Fannie Mae or Freddie Mac," he would say. He came up with two key strategies he believed would insure that Congress never took away Fannie's special status. He called them "indispensability" and "tangibility." To put it simply, he wanted Congress to see that America couldn't live without Fannie Mae. And he wanted Fannie Mae to be practically synonymous with the idea of home-ownership.
The cornerstones of the Johnson political machine were the Fannie Mae Foundation and the company's Partnership Offices ("POs," in Fannie parlance). The foundation had existed in a small form since 1979, but in 1996, Fannie Mae seeded it with $350 million of its own stock and gave it responsibility for Fannie's advertising. Over the past five years the foundation has given away some $500 million to thousands of organizations ranging from the Congressional Black Caucus to the Cold Climate Housing Research Center in Fairbanks.
Fannie began opening its Partnership Offices in 1994. These are regional offices that Fannie says act as catalysts for housing projects in their communities; but inside Fannie, the POs are also referred to as the "grassroots" of the political operation. They are frequently staffed by ex-politicos. (Bob Simpson, who heads the South Dakota office, was an aide to Democratic Senate leader Tom Daschle, for instance.) The opening of a Partnership Office is always a grand ceremony featuring prominent politicians. And it's often accompanied by an announcement that Fannie's American Communities Fund will make an investment in a high-impact local project. Politicians may not understand the secondary-mortgage market, but they do understand a photo opportunity and the dispensation of pork.
Over time, Fannie built close alliances with homebuilders, Realtors, and trade groups--whom it could call on to pressure lawmakers whenever the need arose. It employs more high-powered lobbyists than just about any organization in Washington. It hires people for their political juice, including Duane Duncan, former chief of staff of Republican Congressman Richard Baker of Louisiana (a Fannie critic, as it happens), Michele Davis (a former Paul O'Neill aide), and Robert Zoellick, who is set to become deputy secretary of state.
Under Johnson, Fannie Mae also developed a reputation for invincibility tactics. "You did not question Fannie Mae," says former Housing and Urban Development Secretary Andrew Cuomo, who is proud of winning one skirmish with Fannie. "Fannie did as Fannie wanted." Partly that was because Fannie people had an almost religious conviction about the virtues of housing--a sense that they were both right and righteous.
Another reason for Fannie's uncompromising attitude was Fannie executives' continuing fear that what politics giveth, politics could take away--and their belief that Fannie's congressional charter, which gave it so many advantages in the marketplace, had to be fought for at every turn. There was some truth to this. The Reagan administration, for instance, ideologically opposed to government-subsidized corporations, worked hard to privatize the company. (Fannie beat back the effort.) Fannie execs felt they couldn't afford to lose even one fight, because that would open the floodgates. "You're thinking survival--winning, not compromise," says a former employee. A former Fannie lobbyist adds that the attitude was "Just win, baby."
At the same time Johnson was turning Fannie into a political juggernaut, he was transforming it into one of the greatest growth vehicles ever. In the years Johnson ran Fannie, its market cap grew from $10.5 billion to more than $70 billion. It posted steady earnings gains, and its executives made fortunes. (The wealth-sharing had begun before Johnson; when Maxwell left, he walked away with a $19.5 million retirement package.)
In the mid-1990s, Raines told the Washington Post that "we are the equivalent of a Federal Reserve system for housing." The same article noted that Fannie's financial moves generated more than $100 million a year in fees for Wall Street firms. By the time Johnson retired in late 1998, Fannie guaranteed a stunning $1 trillion of mortgages and held $376 billion of mortgages and mortgage-backed securities on its own books.
Inevitably, Fannie's growth began to prompt serious questions from a variety of critics. There were ideological foes who believed that GSEs shouldn't have special advantages bestowed by the government. The big national banks wanted more of the mortgage securities market--and wanted to see Fannie shackled. Many housing activists believed the company had become so focused on Wall Street that it had lost sight of its mission. What, they asked, did Fannie's ever-growing portfolio do to lower mortgage rates? Other critics looked at that portfolio and saw huge potential risks--risks that would likely be borne by taxpayers if anything went wrong. Financial consultant and prominent GSE critic Bert Ely is among those who argue that Fannie has created a moral hazard; namely, that if everyone thinks the government will rescue the GSEs, the companies aren't subject to market discipline.
Fannie's knee-jerk response to criticism was to push back hard. It accused anyone who questioned it of being anti-home-ownership. In 1996, when the Congressional Budget Office issued a critical study, a Fannie spokesperson sneered that the report was "the work of economic pencil brains who wouldn't recognize something that works for ordinary homebuyers if it hit them in their erasers." And it was quick to remind politicians where their interests lay. Fannie put together a book, personalized for each member of the House Banking Committee, detailing all the good things it did in each district to bolster home-ownership. Even that critical CBO study acknowledged that it would probably be impossible to get rid of the GSEs even if it made economic sense--because Fannie and Freddie had become so inextricably linked to the idea of home-ownership. "Once one agrees to share a canoe with a bear, it is hard to get him out without obtaining his agreement or getting wet," said the report.
¦THE EARNINGS TRAP
"The future is so bright that I am willing to set as a goal that our EPS will double over the next five years."
So said Franklin Raines at an investor conference he hosted in May 1999, five months after becoming CEO. During his tenure, that promise was at the heart of everything the company did. The board even tied much of management's compensation to earnings goals. And though Fannie met the target--announcing profits of $7.3 billion in 2003--the intense focus on consistent earnings growth did a lot to bring Raines down.
In assuming the top job at Fannie, Frank Raines--everyone calls him Frank--became the first African-American CEO of a FORTUNE 500 company. He was born in Seattle to blue-collar parents; his mother cleaned offices at Boeing, where Raines was appointed to the board in 1995. (He is now on the boards of PepsiCo and Pfizer.) Raines graduated from Harvard and Harvard Law, became a Rhodes Scholar, interned in the Nixon White House, and served in the Carter administration before leaving government to become a partner at Lazard Frères. In 1991, Johnson lured him to Fannie Mae, where he became vice chairman. Five years later Raines was named Bill Clinton's budget director; he returned to Fannie when Johnson retired.
Raines, who would not comment for this article, has what Andrew Lowenthal, a lobbyist whose clients include Freddie Mac, calls "extraordinary presence.... You see him, you meet him, you want to believe him." (Some Fannie lobbyists referred to him as "The Great One.") And like Johnson before him, Raines could talk the talk with great sincerity; former Goldman Sachs analyst Bob Hottensen remembers him often telling a story about how his father had to get a high-priced loan rather than a lower-cost mortgage. "You cannot hurt Fannie Mae without hurting the housing market," Raines liked to say. One of his great assets, people said, was his strong will--but that eventually became a liability. "If a lot of people disagree with you, you have to ask, are they all wrong?" says someone who knows Raines well.
Under Raines, Fannie began to come under increasing criticism--and it responded ever more aggressively. In June 1999, for instance, Fannie's banking competitors banded together to form a group called FM Watch. The company reaction can only be described as over-the-top: It called FM Watch "fat-cat bankers," compared it to the ruthless ex-dictator Slobodan Milosevic, and went around hiring powerful lobbying firms just to keep them from working for FM Watch.
FM Watch, however, wasn't the biggest of Fannie's worries. The real problem was that as Fannie's mortgage portfolio continued to balloon, top government officials became concerned about the potential consequences. In late 1999, then Treasury Secretary Lawrence Summers made a speech that included this sentence: "Debates about systemic risk should also now include government sponsored enterprises, which are large and growing rapidly." It was an incendiary remark. Then in March, Gary Gensler, Treasury's undersecretary for domestic finance, suggested in a speech that the Treasury should reconsider Fannie and Freddie's $4.5 billion line of credit.
All hell broke loose. Yields on GSE debt rose dramatically, meaning that investors wanted to be compensated for taking more risk. This, of course, reduced the spread Fannie was able to earn on its portfolio--and threatened Fannie's earnings. Fannie called Gensler "irresponsible," "unprofessional," and (of course) anti-housing. Raines wrote that repealing the line of credit would "disrupt the capital markets and inexorably lead to higher mortgage rates for consumers."
The market reaction was so ugly that Fannie and Freddie realized they had to respond. And so, in an October 2000 press conference, Brendsel and Raines announced "six voluntary initiatives" to disclose more information about, for instance, interest rate risk. Both stocks shot up by almost 10% that day. What few knew was that Raines furiously resisted the "voluntary initiatives" and signed on only when it became clear that Freddie was going to proceed. Speaking to investors later that year, Raines portrayed the initiatives as a triumph, not a retreat. "We didn't stray, we didn't cry uncle, we didn't concede anything that would affect us in the long run."
One of the six voluntary initiatives was that the "duration gap," a measure of sensitivity to interest rates, would be disclosed monthly instead of quarterly. In 2002 accounting sleuths and short-sellers became suspicious of Fannie's smoothly growing earnings. Fannie's duration gap made it clear that the company had been on the wrong side of interest rate bets during a period of rapidly declining rates in the fall of that year. Yet that didn't seem to have had any effect on Fannie's earnings. John Barnett, then an analyst at the Center for Financial Research and Analysis, which produces detailed accounting reports for institutional investors, suggested that Fannie Mae was distorting economic reality by putting billions of dollars in derivative losses on its balance sheet instead of on its income statement. Fannie's responses were rarely illuminating. When Republican Senator Chuck Hagel of Nebraska asked for details on Fannie's derivative losses, the company said the information was "confidential and proprietary." Eventually, it provided some additional data.
In fact the situation was worse than even the harshest critics believed. "We thought their accounting was lousy but legal," said Mark Haefele, who helps run Sonic Capital, a hedge fund that is short Fannie's stock. "It turns out it was just lousy."
¦UNDERFED WATCHDOG
The chain of events that eventually brought Frank Raines down starts with Enron. When the Enron scandal exploded, Freddie Mac, which had employed Enron's accounting firm, Arthur Andersen, quickly fired the firm and hired new accountants. In the fear-ridden environment of 2002, the new accountants, PricewaterhouseCoopers, scrubbed Freddie's books. The result of that scrutiny was Freddie's admission, about a year later, that it had understated its profits for years, in an effort to smooth out earnings. The company agreed to a $5 billion restatement and ousted many of its top executives, including Brendsel.
Fannie responded to Freddie's problems with astonishing self-righteousness. Raines held a press conference in which he accused Freddie of causing "collateral damage." The Frequently Asked Questions section of Fannie's website included the following statement: "Fannie Mae's reported financial results follow Generally Accepted Accounting Principles to the letter.... There should be no question about our accounting."
Just days before the Freddie crisis had erupted into public view, the Office of Federal Housing Enterprise Oversight (OFHEO)--the agency that regulates the GSEs--had pronounced Freddie's internal controls "accurate and reliable." This was a colossal misjudgment. Embarrassed by the error, OFHEO's director, a Texas Democrat named Armando Falcon Jr., who had been appointed to his job in 1999, resolved to make sure it didn't happen again. In early 2004, OFHEO hired Deloitte & Touche and began an investigation of Fannie Mae. The lead partner was Bob Maxant, who had previously handled the Enron board's in-house investigation.
OFHEO is not like most regulatory agencies; it is much weaker. Established in 1992, OFHEO is actually an illustration of Fannie's political power. When the legislation creating the agency was being debated, Fannie's allies in Congress made sure OFHEO was placed in the Department of Housing and Urban Development, which had no experience regulating financial markets. In the years prior to Falcon's appointment it was notoriously understaffed. Although its budget comes from fees paid by the GSEs, a Fannie-inspired amendment called for OFHEO to go through the appropriations process every year. Since Fannie and Freddie had numerous allies in Congress, this meant that the GSEs would effectively control their regulator. OFHEO, says one person who was there, had two choices: "Appease Fannie and Freddie or risk getting reamed in the budget." Former Treasury official Carnell once described OFHEO as a watchdog that was "hobbled, muzzled, and underfed."
It's fair to say that Fannie underestimated Falcon. The OFHEO chief, who is 44, seems shy and hesitates when he speaks. He's the middle of six children, raised outside San Antonio; his father was an aircraft mechanic. After attending St. Mary's, a Catholic college in San Antonio, he went to the University of Texas Law School and the Kennedy School of Government. He came to Washington in 1989 to work on the House Banking Committee under its populist chairman, Henry Gonzales, for eight years. After a failed political run in Texas, Falcon returned to D.C. and was appointed by Clinton to his current job. He didn't initially distrust Fannie or Freddie. But after wrangling with the GSEs, he became convinced that the last thing Fannie wanted was a capable regulator.
At first, it didn't look as if Falcon would last. (He is, after all, a Texas Democrat.) In February 2003 the White House announced that it planned to nominate a former J.P. Morgan executive named Mark Brickell to replace him. But Brickell's nomination was killed by foes who believed he was too close to the derivatives industry, and in the meantime the White House was warming up to Falcon. Later in 2003 the administration signaled its support for the agency by pointedly adding it to the President's corporate fraud task force. And it was the White House that got OFHEO the funds to hire Deloitte & Touche to investigate Fannie.
It would be wrong to say that OFHEO and the White House became allies. It was more like a wary marriage of convenience. What happened was that the White House's attitude toward the GSEs had changed--and it saw that OFHEO could help its cause.
¦OPERATION NORIEGA
There are people in Washington who will tell you that the White House turned on Fannie Mae because it's seen as a Democratic Party stronghold. There are others who will say it happened because of the Bush administration's pro-market ideology. There's probably some truth to both of those explanations. But the most important reason was self-preservation. The White House didn't want to be dragged into another business scandal--not after Enron. And when it looked to see where it might be vulnerable, well, considering what was going on with Freddie, it could hardly miss the GSEs.
First, there was the issue of Freddie's and Fannie's boards. Under their charters, five of the 18 directors on each board are appointed by the President. If something went wrong, wouldn't the President inevitably be blamed? In 2003 chief of staff Andrew Card was put in charge of a group to study the matter. The White House decided that it would not reappoint any presidential directors to either GSE board. (The posts are now vacant.) It also decided that their books needed to be cleaned up and they needed stronger oversight.
At the same time Alan Greenspan's public remarks about the GSEs were becoming increasingly pointed. His sharpest comments came in early 2004, when he told Congress that "to fend off future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventative actions are required sooner rather than later." In Greenspan-speak, those were strong words indeed.
The White House became part of a loose alliance that took on the Fannie Mae machine in a way no one had before. A short list of examples:
• In late 2003, Federal Reserve economist Wayne Passmore released a paper that put the value of the government's implied guarantee of the GSEs at as much as $164 billion. This subsidy "accounts for much of the GSEs market value," wrote Passmore, who added that "the GSEs' implicit subsidy does not appear to have substantially increased home-ownership or homebuilding." He also argued that the GSEs did very little to lower mortgage costs.
• HUD toughened its low-income housing goals for Fannie and Freddie--and then insisted the GSEs meet the new requirements. HUD had long felt that Fannie and Freddie were not doing enough to promote affordable housing. "HUD had permitted Fannie and Freddie to consistently dispute our findings and challenge us publicly," says Alphonso Jackson, the current head of HUD. "Not on my watch and not under this President." ("You just cannot appreciate how truly bad this is," a Fannie employee complained in an e-mail to a Republican staffer, referring to the prospect of HUD having more clout.)
• In the summer of 2004 the Justice Department rendered an opinion--which Fannie and Freddie had viewed as bad news--that Treasury could actually limit future debt issuance by the GSEs.
• Administration operatives began making anti-Fannie arguments to key opinion makers, such as the editorial boards of major newspapers. They seem to have had an impact. Over the past year anti-GSE editorials have appeared in key papers--not just the Wall Street Journal, but also the Washington Post,the Los Angeles Times, and the Christian Science Monitor.
Aides battling the GSEs came up with a half-joking code name for their assault: "Noriega"--as in Manuel Noriega, the former Panamanian dictator who was blasted with nonstop rock music from loudspeakers while holed up in the Vatican's diplomatic mission in Panama City, trying to avoid surrendering to the U.S. Attack mode, of course, has always been Fannie's way, but now the situation was reversed. As one former lobbyist for the GSEs put it: "Payback is hell."
On Sept. 10, 2003, Treasury Secretary John Snow and then-HUD head Mel Martinez outlined the administration's thinking on reforming Fannie and Freddie. Testifying before the House Financial Services Committee, Snow called for a new regulatory regime, one key element of which would be a receivership provision. Amazingly, there is no real procedure in place for reorganizing Fannie or Freddie in the event of a bankruptcy. By setting up a receivership mechanism, the government would be sending an unmistakable message: It would not stand behind Fannie and Freddie's debt.
It wasn't long before Fannie and the administration were effectively at war. Two bills to reform the GSEs were introduced--a Fannie-friendly bill in the House and a White House--friendly bill in the Senate sponsored by Republican Senator Richard Shelby of Alabama. The administration squashed the House bill; Wayne Abernathy, a Treasury official, said, "We must not settle for a crippled regulator." The Senate bill was moving along--until Republican Senator Bob Bennett of Utah (who had the backing of other Senators) added an amendment giving Congress a 45-day window to veto the receivership. That, of course, completely undercut the notion that the government would no longer back the GSEs. Bennett's son is the deputy director of Fannie's Partnership Office in Utah.
At every turn, Fannie declared publicly its desire for a strong new regulator. And at every turn, it stonewalled behind the scenes. "No, no, hell no," is how one person who watched the process describes Fannie's attitude. Some administration officials began to refer to Fannie's efforts to undermine the receivership provision as "deceivership."
On Oct. 22, 2003, for instance, Raines sent Snow a letter. "Dear John," it began. "From the beginning of our discussions, you and I have agreed to avoid disrupting the capital markets by indicating a wish to change Fannie Mae's charter, status, or mission." After complaining about a comment that Raines said a high Treasury official had made about Fannie's line of credit, he wrote, "The result of his comment was that trading in our debt came to a halt for an extended period of time. I am disappointed and hope we can change course. Very truly yours, Frank."
In political terms the letter was an astonishment--what other CEO would dare dress down the Treasury Secretary, much less address him as "Dear John"?
(In the spring of 2004, Snow announced that his financial advisor had mistakenly bought GSE debt for his personal account instead of Treasury bills. Months later, Democratic Senator Max Baucus, who is featured in a Fannie press release for its Montana Partnership Office, referred the matter to the Justice Department "for review.")
Then, in 2004, Raines wrote another stern letter, this one to White House chief of staff Card, accusing Card of misrepresenting Fannie's position on a regulation issue to the National Association of Home Builders. Card first learned of the letter from the NAHB because it got a copy before he did. After that, Card stopped returning Raines's phone calls. "It's hard to depersonalize these things," says NAHB CEO Jerry Howard. "It's hard to step back."
And then there was the TV ad Fannie ran on March 31, 2004--the day before the Senate Banking Committee was scheduled to work on its bill. The ad featured a worried looking Hispanic couple.
Man: "Uh-oh."
Woman: "What?"
Man: "It looks like Congress is talking about new regulations for Fannie Mae."
Woman: "Will that keep us from getting that lower mortgage rate?"
Man: "Some economists say rates may go up."
Woman: "But that could mean we won't be able to afford the new house.
Man: "I know."
Even longtime Fannie watchers were stunned. "Here is an organization that was created by the Congress ... spending money questioning the Congress's right to take a serious look at oversight ..." sputtered Senator Hagel during the hearing that day. "I find it astounding. Astounding!"
By late spring 2004 it was clear that Fannie had fought the White House to a draw--there would be no bill, and hence no new regulator. But it's all too clear now that Fannie Mae had won a Pyrrhic victory. Raines would have been far better served by compromising when he had the chance. Thanks to the accounting scandal, the GSEs now face regulations that are likely to be far tougher than those in the bill Fannie helped kill. One former Fannie lobbyist describes it as "the greatest political malpractice ever committed." Says another person close to the events: "What is amazing to me is Raines's will and misjudgment to continue fighting in the face of the first truly organized resistance the company had ever faced. To this day I don't know if he fought because he thought he was right, or because he knew the company's actions were so wrong."
¦FIGHTING FALCON
On Sept. 22, 2004, OFHEO released results of its continuing investigation. The "Special Examination of Fannie Mae" was a dense 211 pages packed with technical accounting details. But the message was clear: OFHEO accused Fannie Mae of both willfully breaking accounting rules and fostering an environment of "weak or nonexistent" internal controls. OFHEO focused on exactly the issue that the skeptics had earlier noticed, which was Fannie's use of accounting rules to defer derivative losses onto its balance sheet. Except OFHEO said that Fannie hadn't just bent the rules, it had broken them.
What got the most attention, though, was OFHEO's charge that in 1998, when an internal model said Fannie would need to recognize a roughly $400 million expense, Fannie only recognized $200 million. That, OFHEO charged, allowed the company to report earnings of $3.23 per share, which meant that Fannie paid out a total of about $27 million in bonuses. Both the SEC and Justice quickly announced their own investigations.
Two weeks later Falcon and Raines faced off against each other in a hearing before the House subcommittee on capital markets, which was chaired by Baker. Consider the circumstances. Falcon was Fannie's regulator and had leveled serious charges, amounting to fraud, against Fannie Mae. Most CEOs would have seen the wisdom of humility at this point, but Raines showed little. "These accounting standards are highly complex and require determinations on which experts often disagree," he said, adding that "there were no facts" that supported OFHEO's charge that Fannie executives had deferred an expense in 1998 to earn bonuses.
And most of the Democrats present agreed with him. "This hearing is about the political lynching of Franklin Raines," said Congressman William Lacy Clay of Missouri. Massachusetts Congressman Barney Frank said, "I see nothing in here that suggests that safety and soundness are an issue." Other Democrats complained that the mere fact of releasing the report could increase the cost of home-ownership.
"Is it possible that by casting all of these aspersions ... you potentially are weakening this institution in the market, that you are potentially weakening the housing market in this country?" Congressman Artur Davis of Alabama demanded. When Falcon tried to answer, Davis acted like a prosecutor grilling a hostile witness. He wanted a one-word answer: yes or no. "Is that possible?" he asked again.
"I have never seen anyone treated as disrespectfully as Armando Falcon was by the Democrats and by Franklin Raines," recalls one congressional aide. Adds Andrew Cuomo: "I credit him for not folding and not caving and not running, because he took a tremendous beating."
One of the few bad moments for Fannie came when Baker released information showing that over five years, Fannie had paid its 20 top executives a combined $245 million in bonuses. In 2002 its 21 top executives each earned more than $1 million in total compensation. Even the Democrats winced.
Fannie had one last card to play. Back in April, Republican Senator Kit Bond of Missouri, a member of the Senate Appropriations Committee, had spurred the HUD inspector general to investigate OFHEO. (One of Bond's staffers, John Kamark, is a Fannie supporter who plays poker with Bill Maloni, Fannie's former chief lobbyist and current consultant.) Although the report had only been finished the previous day, and wasn't public, it was clear at the hearing that some members of Congress had already been briefed on it.
The report does not put Falcon or OFHEO in a flattering light. It quotes a "confidential source" inside OFHEO saying that Falcon's top deputy would become "almost gleeful" whenever Fannie's stock declined. This same source said that "OFHEO was trying to embarrass Fannie Mae." In other words, OFHEO wasn't just regulating Fannie Mae, it was out to get Fannie Mae. "This makes it difficult to assess the reliability of recent allegations by OFHEO against Fannie Mae," declared Congressman Frank.
It is true that the SEC would never have done some of the things OFHEO did. But OFHEO supporters say the agency had to play hardball. It was an outgunned regulator trying to investigate one of the nation's most politically powerful companies. And Fannie was being Fannie. For instance, one of the complaints Fannie's allies leveled at OFHEO was that it released the results of an ongoing investigation to the public, something no real regulator would do. But there is an explanation. One source close to the events says OFHEO had told Fannie's board that it wouldn't release the report. But the OFHEO people learned that Fannie lobbyists were telling members of Congress that the report was inconsequential and Falcon wouldn't release it because he didn't want to exonerate Fannie. And so OFHEO released the report.
For his part, Falcon refused to be moved by the barrage of criticism from his fellow Democrats. To him the problems at Fannie were reminiscent of the S&L crisis. He told a friend that the Democrats were "so blinded by their loyalty to Fannie that they can't see what's really happening. If they want to repeat history, I won't be part of it."
Wall Street, of course, was every bit as blind. After the hearing, analyst Bob Napoli at Piper Jaffray wrote: "We thought Frank Raines in particular made excellent points countering OFHEO accusations, in some cases directly contradicting OFHEO assertions." Jonathan Gray of Sanford Bernstein wrote that the "allegations lack cogency," and said, "Plausible charges against FNM are immaterial, while material charges are implausible." (And he noted that "a John Kerry victory would improve the political climate.")
And then Frank Raines overplayed his hand one last time. In a highly unusual move, Fannie insisted that the SEC review OFHEO's accounting allegations. Fannie hired the powerful law firm of Wilmer Cutler to help it make its case; Bill McLucas, the lead partner on the Fannie team, was formerly the SEC's chief enforcement officer. The potential danger of this request was obvious: In a worst-case scenario, if the SEC completely sided with OFHEO, Fannie would have to restate earnings going back to 2001. And the restatement would be massive--an estimated $9 billion in losses. Some Fannie people referred to the restatement possibility as the "ultimate penalty." But, in truth, they really did not seem to think that the SEC would rule against them.
¦FRANK'S FINALE
At a little after 6 P.M. on Dec. 15, about 30 people--including Raines, three members of Fannie's board, Wilmer Cutler lawyers, Armando Falcon, representatives from KPMG and Deloitte & Touche, and Justice Department officials--piled into a conference room at the SEC's headquarters in Washington, D.C., and seated themselves around a large rectangular table. SEC officials first made it clear that they had not addressed any issues of individual culpability--those investigations were ongoing. Then, chief accountant Donald Nicolaisen announced that the SEC had decided that Fannie did not comply "in material respects" with accounting rules, and that as a result, Fannie would have to restate its results.
Raines looked stricken. One person who was there says it was the first time he'd ever heard Raines's voice waver. "What did we get wrong?" he asked. Nicolaisen held up a piece of paper. If the four corners of the sheet represented what was possible under GAAP, and the center was perfect compliance, he told Raines, "you weren't even on the page." Fannie representatives tried to argue that if they couldn't get it right, no one could. Nicolaisen wasn't having any of it. "Many companies out there get it right," he said.
It was over for Frank Raines. Falcon told the Fannie board that Raines and CFO Howard had to go, and though Raines fought to keep his job over the next week, holding individuals meetings with board members, he had run out of options. On Dec. 21, Raines announced his resignation. "Although to my knowledge, the company has always made good faith efforts to get its accounting right, the SEC has determined that mistakes were made. By my early retirement, I have held myself accountable," he said. Tim Howard also resigned, and Fannie fired its accountant.
After the Enron scandal broke, nobody defended Ken Lay or Jeff Skilling. But in the wake of the Fannie Mae scandal, Raines still had legions of supporters. There are plenty of people who still believe that what's good for Fannie is good for home-ownership--and that the whole thing was little more than a political dirty trick. "They're just not dishonest in any way," says Martin Eakes, who runs the Self-Help Credit Bureau in North Carolina. "It's a little hard for me to swallow that what appears to me to be a hatchet job by OFHEO has basically been validated by the SEC.... You mark my words, you will not find scandal there or fraud."
As for Wall Street, it has its own reasons for defending Fannie, which is still one of the Street's top fee-payers. "The overwhelming majority of FNM's accounting is correct," wrote a Lehman Brothers analyst. "We view this infraction as a speeding ticket, not a capital offense." Bear Stearns analysts concluded that Raines and Howard had been ousted because of OFHEO's "personal animosity toward the CFO and CEO."
A key tenet of the Street's defense of Fannie is that the $9 billion restatement doesn't really constitute an economic loss. It's just an accounting issue, "technical in nature," as one analyst said.
The other view, of course, is that the $9 billion represents losses that Fannie should have taken--but didn't--since 2001. And that in avoiding those losses, Fannie's top executives collected millions in bonuses they didn't earn.
The restatement will put Fannie well below its regulatory capital requirements, which is why the company quickly sold $5 billion of preferred stock. Nothing says more about the Street's continued belief in Fannie than the ease with which it was able to raise that money. In coming months it will have to raise billions more.
Yet the notion that the worst is over may well turn out to be misguided. "Dig deep into what's there and you find more and more," says a person close to the investigation. One possible example: Critics note that Fannie has $9.1 billion of deferred tax assets included in its regulatory capital measure. Most of these assets were generated because Fannie suffered massive losses on its derivatives; they are an offset to future taxes Fannie might owe. But Lawrence Kam of hedge fund Sonic Capital says the inclusion of these assets in regulatory capital is unhealthy--he notes that bank regulators severely restrict the amount of such assets that can be included in a bank's regulatory capital. (Fannie has previously argued that the number is less than $9 billion, and that its regulatory statutes do not limit the inclusion of deferred tax assets in regulatory capital.)
Another question that has been lost in the political wrangling is whether Fannie's business has changed permanently for the worse. Over the past 18 months the growth in Fannie Mae's portfolio has slowed sharply because of competition from banks and hedge funds, which are financing their mortgage purchases with cheap, short-term debt (a technique known as the carry trade). Back in 2002 the spread between the yield of Fannie's mortgage portfolio and its long-term liabilities was 63 basis points. In the second quarter of 2004 it had fallen to two basis points. To keep profits up, it looks like Fannie, which has disparaged the carry trade as too risky, may now be using the strategy itself, which would make it more vulnerable to rising interest rates. The company disputes this analysis, pointing to its one-month duration gap as a sign that it is not taking interest rate risk. Still, Josh Rosner, an analyst at Medley Global Advisors, who has made a string of accurate calls on GSEs, says a diminished spread is "absolutely permanent."
And then there's the question of whether there will finally be new legislation. Senator Richard Shelby vows to try again. "They [Fannie] didn't listen because they thought they could thwart the whole deal, but time is on our side. We're coming back," he says. But the administration may no longer need legislation to force change at the GSEs. If other bad news emerges, if the spreads continue to shrink--there are a lot of things that could happen in the coming months that will force their own kind of reform.
What Fannie and Freddie may not be able to do any longer is to have it both ways. They can't profess to be devoted to the mission of providing affordable housing while generating turbocharged earnings growth. Freddie's new CEO, Dick Syron, concedes that the company won't grow at anywhere near the rates of the 1990s. He also concedes that the company has not done as much as it should have for affordable housing. "If we're going to have special privileges, then we have to do something special," he says. One of Syron's first moves was to redo management compensation to be weighted toward the achievement of affordable housing goals. "No one chartered us to be Goldman Sachs on the Potomac."
Fannie's new CEO, Dan Mudd, also insists that the mission has to come first. "To the extent that this company strays from its mission of financing affordable housing, we start to lose our compass." He also says that the company will begin to listen to its critics, and admits that "there are areas we have gotten arrogant."
But if Washington has learned anything about Fannie Mae, it's to watch what it does, not what it says.
Here's dirtly little secret..there's magic in all accounting. Oops. It is out.
It might just get out of Committee. Remember the House Committee passed 18 GSE reforms bills in the last Congress (113th) and then they all died. Same excercise here.
Hensarling's bill is "an ideologically pure exercise, which will never have a single Democratic supporter"
And the Senate bill will not hold water! And with Watt in control, AMERICA WILL BE SAFE.
Senate GSE Bill Has Best Chance For Broad Support, Backers Say
American Banker - Jul 18, 2013
WASHINGTON — The two authors of a Senate bill aimed at overhauling the mortgage finance system said Wednesday their legislation achieves the kind of balance needed to attract support from both parties.
Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., discussed their proposal to wind down Fannie Mae and Freddie Mac , and replace the two government-sponsored enterprises with private mortgage insurers, at an event sponsored by the Bipartisan Policy Center . The legislation would create a new agency, called the Federal Mortgage Insurance Corp., to regulate private insurers and provide them with a catastrophic guarantee.
Warner said the bill is a more serious attempt at gaining broad support than a competing plan in the House championed by Financial Services Committee Chairman Jeb Hensarling, R-Texas, and other Republicans. The House plan would fully privatize the mortgage finance market.
Hensarling's bill is "an ideologically pure exercise, which will never have a single Democratic supporter," Warner "The biggest impact, I think, is a philosophical one and that is in bringing both finality to the issue and certainty to the industry, to consumers, to staff at bureau and other agencies," he said. "The greatest thing is simply certainty."
"I give [Hensarling] credit for an exercise that lays out a very coherent approach. I question whether outside of the [Financial Services] committee it will even get a broad base of Republicans. It will completely upend our housing finance system. It would destroy the 30-year fixed mortgage. It would destroy the ability of so many of the purchasers of these securities — both domestic and particularly foreign purchasers — because they need that government backstop."
Corker, meanwhile, defended Hensarling's efforts, noting that he introduced a similar bill in the Senate just two years ago. Yet he acknowledged that the House legislation would be difficult to pass.
"I found myself as the only sponsor of this piece of legislation," Corker said of his earlier bill that would have cut out government involvement in the market. He said his plan crafted with Warner "strikes the appropriate balance."
The lawmakers also defended their decision to require private capital to cover the first 10% of credit risk in the plan, a figure that has drawn some skepticism from observers.
"The bottom line is, around here you make everything up, so we decided on 10% and that's where we are," Corker said jokingly.
Warner said the market will ultimately be crucial for helping to determine how that 10% is structured. Both lawmakers emphasized during the discussion that the bill is a work in progress and will benefit from industry input.
"That whole notion of taking that 10%, it may be tranched into different components. I'd rather overshoot on protecting the taxpayer and recognize that it may be tranched — it may be tranched such that the first 5 or 6% is priced at a higher rate of return than the balance. I actually think the market can help us get this right."
Dude - Buck up we are at or near the bottom compared to price FnF will hit in the future. There is no other real alternative to FnF for this huge and important market.
Great find J.
A must read: Grand Theft Treasury
by Richard A. Epstein (Peter and Kirsten Bedford Senior Fellow and member of the Property Rights, Freedom, and Prosperity Task Force)
The U.S. government has unconstitutionally stripped billions of dollars from Fannie and Freddie’s private investors.
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Last week’s headline financial story was full of good news for the body politic. The United States Treasury reported a handsome second-quarter profit of $118 billion, which could cut down the deficit and postpone any politically charged negotiations over raising the debt ceiling. Half of that surplus comes from a combination of revenue increases from a slowly improving economy and expenditure cuts introduced in early 2013. The second half consists of a $59 billion “dividend” from Treasury’s “investment” to bail out The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac).
epstein
Illustration by Barbara Kelley
To call that money a “dividend” relies on a profound public misunderstanding of the complex transactions that generated this ill-begotten Treasury bonanza. These transactions are being challenged in four separate lawsuits, which were recently filed, that attack the propriety of virtually every government action during the turbulent past five years. (Full Disclosure: within the past several months, I been hired by several hedge funds to advise them privately on the legal issues surrounding these events.)
The oft-neglected back-story of the “Fannie and Freddie Dividend” casts these transactions in a much darker light. Quite simply, the behavior of the U.S. government over the past five years has been marred by grave legal violations of bedrock principles underlying corporate, administrative, and constitutional law. The Back-Story
Act One: Organizing the Bailout
Prior to August 2008, both Fannie Mae and Freddie Mac were privately owned, publicly traded, and consistently profitable corporations that had issued large amounts of common stock and multiple classes of preferred stock. But both Fannie and Freddie were in obvious distress during the run-up to the September 2008 financial market meltdown, which prompted Congress to pass the Housing and Economic Recovery Act of 2008 (HERA) in July of that year. That behemoth law authorized the Federal Housing Finance Administration (FHFA) to place the corporations into a temporary conservatorship to preserve and to manage their assets in ways that would help stabilize the housing market.
Pursuant to that authority, the FHFA became conservator of both companies in September 2008. It promptly made a deal with the Department of Treasury under which Treasury would advance $100 billion (extended in May 2009 to $200 billion) in exchange for $1 billion in shares of senior preferred stock, which had an original face value of $1 billion dollars. That preferred stock would be increased dollar-for-dollar by any sums that the Treasury invested into either corporation and it carried a 10 percent dividend. At the same time, the Treasury received warrants to purchase 79.9 percent of the common stock of each entity for a nominal price measured in tiny fractions of a penny.
Section 1117 of HERA gave Treasury broad discretion on the terms and conditions that attached to its preferred stock, but it also required Treasury to take into account a number of conditions that related to the soundness of the government’s security for its advances and to the “orderly resumption or private market funding or capital market access,” which would allow Fannie and Freddie to each maintain their status “as a private shareholder-owned company.” Shortly after the 2008 deal went into effect, the value of the common and preferred shares both plummeted.
Act Two: The Third Amended Agreement
I will pass by the many complications that occurred between September 2008 and August 2012 to focus on The Third Amendment to the original stock purchase agreement of August 17, 2012, signed by both Edward Demarco, Acting Director of FHFA, and then Treasury Secretary Timothy Geithner.
Its key provision simply ordered what the Treasury trumpeted, in bold type, would be (as of January 1, 2013) “a full income sweep of All Future Fannie Mae and Freddie Mac Earnings to Benefit Taxpayers for Their Investment.” Treasury announced the sweep only after it became clear that both Fannie and Freddie were returning to profitability. The stock prices of both sets of shares plummeted. By the terms of the deal, nothing was left for either’s set of shareholders in the absence of political relief or a successful lawsuit.
The Flaws of the Government Position
The Conservator’s Conflict of Interest
The shareholders’ grievance is quite simple: the disappearance of their wealth. The purpose of a conservatorship is to preserve the assets for the benefit of the individuals whom it represents, which in this instance covers both classes of shareholders. Accordingly, the conservator represents the shareholders in their relationship with the government. Under standard corporate law principles, that conservator is bound, as his name suggests, by a strong fiduciary duty to protect its assets for the benefit of both its common and preferred shareholders.
In this case, however, the designation of the FHFA as the conservator created an impossible conflict of interest. The Boards of Directors of Fannie and Freddie were shut out of the deliberations that took place exclusively between branches of the federal government.
Given that exclusion, the terms of the financial deal between the corporations and Treasury must be examined to see that in discharging their mandate “to protect the taxpayers,” the two government parties did not run roughshod over the issues of the preferred and common shareholders. Yet, as the plaintiffs allege in Washington Mutual v. United States, there was ample evidence that Treasury exaggerated the financial dangers to Fannie and Freddie in 2008, and thus imposed financial terms that were far too favorable to its own interests, since both Fannie and Freddie had substantial amounts of liquid assets to meet any claims. No wonder share prices plummeted in response to both the 2008 and 2012 deals.
By the standards of corporate governance, these transactions are not protected by the ”business judgment” rule, which is intended to give protection to the good faith judgment of corporate fiduciaries when they are acting in the best of interests of the shareholders with outsiders. That rule is needed to protect officers and directors, for no one will take those jobs if he knows that he gets nothing special when he works well, but suffers huge liabilities if an uncertain deal turns sour.
In this case, however, we have a manifest case of self-dealing between branches of the United States government, at which point the law protects the shareholders by insisting that the parties to the transaction show that it supplied full value to the shareholders. At the time of the 2008 deal, the Office of the Inspector General inside FHFA concluded that the deal had rendered the common and preferred shares “almost worthless.”
It takes no special acumen to realize that the 2012 transaction was completely one-sided; FHFA and Treasury used a fancy set of legal maneuvers to strip both corporations of their assets for the sole benefit of the government. Generally, senior preferred shareholders are entitled to recover their principal and interest in full, after which their shares are cancelled. In this case, the government did precisely the opposite. It treated Fannie and Freddie as gifts that keep on giving, wiping out all shareholder profits.
This breach of duty is so blatant that the only serious question is how best to unscramble the omelet. To make a long story short, there are two ways forward. First, and easiest, is simply to annul the August 2012 Amendment so that the government uses its recent receipts to write down the principal and interest owed prior to that date. Second, and trickier, is to reevaluate the terms of the 2008 transaction and write down the size of the government’s senior preferred shares to fairly reflect the financial condition of the company at the same time.
The Administrative Procedure Act
The August 2012 actions are also in flat violation of the basic duties of government actors under the Administrative Procedure Act (APA), which is addressed in one claim filed in Fairholme Funds v. FHFA and a second filed in Perry Capital v. Lew. The gist of these two actions is that Treasury and FHFA are not at liberty to ignore all of the procedural safeguards that were explicitly built into HERA. Any decision of this magnitude must be set aside when no government official has addressed the explicit statutory “considerations” that are supposed to guide their behavior.
There is no way that a statutory scheme that was intended to nurse Fannie and Freddie back to health as private corporations can be used unilaterally by the government to devour the interests of the very private shareholders that they were intended to protect. Government actions that don’t comply with the minimum standards of the APA should have no force and effect. Thus, even if the 2008 transaction stands, the 2012 transaction should be nullified, and the private and common shares restored.
The Takings Issue
The third approach to this problem, taken both in Washington Mutual and Cacciapelle v. United States, hones in on the de facto confiscation of the common and preferred stock of these companies by the unilateral government action. On this view, the government can keep the shares so long as it buys out the shareholders at fair market value. The law of takings, with its just compensation requirement, is intended to make sure that the government does not, in the famous words of the 1960 case of Armstrong v. United States, force “some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.”
Regrettably, that is exactly what is being done here. The government could never announce that it had decided to seize the shares of Fannie and Freddie, without compensating their owners. Nor can it circumvent that fundamental principle by “amending” a supervisory agreement so that it sucks all the wealth out of those shares. The government’s position is yet more precarious when one considers that the crisis in the housing market was due to the reckless policies that the United States forced on Fannie and Freddie prior to 2008. If Congress makes the mess, it can hardly expect the shareholders whom it targeted to bear the brunt of its misdeeds.
Some Ominous Social Implications
All three routes therefore lead to the same conclusion. The whole sorry episode represents a form of serious government coercion, with public officials attempting to run roughshod over bedrock principles of corporate, administrative, and property law. It is therefore a sad commentary on the current situation that Republican Senator Bob Corker of Tennessee has introduced the high sounding Housing Finance Reform and Taxpayer Protection Act that is intended to wind down the operations of Fannie and Freddie, which does nothing whatsoever to undo the massive property grab undertaken over the past five years.
There is no doubt that this legislation will attract popular support because it demonizes hedge funds and profits taxpayers in the short run. But it is vital to remember the long run. This dispute involves lots more than a simple battle over the proceeds of profitable ventures. All capital markets depend on the strong protection of the rule of law so that firms that invest their capital today can be confident that the government will not steal it away by stealth and artifice tomorrow, which is just what is happening now on a multibillion dollar level.
In 2009, I wrote at some length about the dangers of “political bankruptcies” in relation to the General Motors and Chrysler bailouts, which also ran roughshod over the rule of law. At the time, people said it was a one-off situation. After Fannie and Freddie, those words ring hollow. The only way to raise capital at the front end is to stick to the rules of the game throughout the transaction. We now seem to have some bipartisan support for the opposite position, which is one more sober reminder of how far the nation has drifted from the sound and enduring principles of strong property rights and limited government
It takes no special acumen to realize that the 2012 transaction was completely one-sided; FHFA and Treasury used a fancy set of legal maneuvers to strip both corporations of their assets for the sole benefit of the government. Generally, senior preferred shareholders are entitled to recover their principal and interest in full, after which their shares are cancelled. In this case, the government did precisely the opposite. It treated Fannie and Freddie as gifts that keep on giving, wiping out all shareholder profits.
This breach of duty is so blatant that the only serious question is how best to unscramble the omelet. To make a long story short, there are two ways forward. First, and easiest, is simply to annul the August 2012 Amendment so that the government uses its recent receipts to write down the principal and interest owed prior to that date. Second, and trickier, is to reevaluate the terms of the 2008 transaction and write down the size of the government’s senior preferred shares to fairly reflect the financial condition of the company at the same time.
ANOTHER LOVELY PIECE FROM STANDFORD!
Right Ob; that is what I meant to type. My bad.
DeMarco is a high ranking civil servant only there for stop gap purposes whereas Watt would be a White House political appointee confirmed by the Senate wearing the full mantle of authotity.
Senate still on path for Tuesday 'nuclear option' vote
Susan Davis, USA TODAY 10:23 p.m. EDT July 15, 2013
Harry Reid
(Photo: Pablo Martinez Monsivais, AP)
Story Highlights
Late Monday meeting fails to achieve compromise
Rules change would reduce number of votes needed to approve executive branch appointees
Republicans cry foul, warn of lasting damage to the Senate
SHARE 431 CONNECT 42 TWEET 29 COMMENTEMAILMORE
WASHINGTON — The U.S. Senate is going nuclear.
Barring a last-minute deal, Senate Majority Leader Harry Reid, D-Nev., made clear he will move forward Tuesday with a controversial maneuver — known as the "nuclear option" — to change the chamber's rules to make it easier to confirm President Obama's executive branch nominees.
"I love the Senate. But right now the Senate is broken and needs to be fixed," Reid said at a Monday address at the Center for American Progress, a liberal think tank, in which he defended his decision to change Senate rules. Senators of both parties have warned the rules change could tear apart the traditions and comity for which the chamber is historically known.
Senators huddled privately late Monday evening in the Old Senate Chamber on the second floor of the U.S. Capitol to see if a bipartisan deal could be reached to head off Reid's plan. But after three hours, the meeting broke up without any resolution.
"There was a very good discussion but at this point we're headed to votes," said. Sen. Tom Udall, D-N.M., who supports changing the rules.
Without a deal, Reid said he would force a vote Tuesday to lower the number of votes needed to end a filibuster of an executive branch nominee from 60 to 51 votes. The rules change could be accomplished with a simple majority vote, and Democrats have 54 votes in the chamber.
"That is not minor. That is a big deal," said Sen. Jeff Flake, R-Ariz., a freshman in the chamber, who voiced a commonly held view that changing the filibuster rules on executive branch nominees could lead to changes in how the Senate approves judicial nominees or passes bills.
Reid has pledged not to expand the new rules beyond executive branch nominations. He argues such nominees should be approved by a simple majority. "This does not affect lifetime appointments. It doesn't affect substantive legislation. It allows the president to have his team -- this president and those in the future. And that's the way it should be," he said.
White House spokesman Jay Carney said Monday that the president defers to Reid's judgment on procedural matters, but he made clear the administration's frustration with the nomination process. "Republicans have needlessly and systematically obstructed our nominees even though the individuals the president has nominated for these posts have extraordinary credentials and bipartisan support," he said, "So, you know, gridlock is something we've seen in Washington for some time, but the Republicans in the Senate have brought gridlock to new heights, or new lows, depending on how you look at it."
Democrats cite 16 filibusters of Obama nominees as the impetus for the rules change, compared to 20 filibusters on executive nominations for all other presidents prior to Obama. In particular, Democrats are incensed by long-standing Republican holds on nominees to the National Labor Relations Board and the Consumer Financial Protection Bureau. Republicans have deep philosophical objections to the work of both agencies.
"We have a situation where Republicans have created gridlock, gridlock, gridlock. And it has consequences. It's not only bad for President Obama, it's bad for the country. The status quo won't work," Reid said.
Republicans counter that only four of Obama's nominees have been blocked, while 1,560 have been approved, and no Cabinet nominees have been defeated.
Minority Leader Mitch McConnell, R-Ky., strongly opposes the move. He has not laid out how Republicans will respond if the nuclear option is successfully employed, but Senate rules provide lawmakers with a broad array of procedural tactics to delay or obstruct Senate business in committees and on the floor.
This is the second time in nearly a decade the U.S. Senate was brought to the brink on the nuclear option. In 2005, the GOP-controlled Senate almost invoked the nuclear option on judicial nominees under President Bush, but a group of 14 senators reached a deal to avert it at the last minute.
Reid, then the minority leader, was strongly opposed to the nuclear option at that time. "It's a new era," he said, when asked Monday about his change of mind
and let me add my belated salute as well. Not sure what your yearly retainer is but I am sure it is not within my approved budget.
Exactly right. Goes back to the Raines's days. These guys need to look forward. Watt will help with that. The GSE model is in fact a great model.
Ed DeMarco is good guy following the law. Remember he is civil servant not an appointee of the Presidnet, confirmed by the Senate...like Watt will be.
Hold your shares tight. You bet.
That don't rust! These folks are all over the place. Expect some noise and baby steps but no bills will be passed this year.
Tool or not he is not embracing the bill of his party.