Mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC) have seen their stocks soar 185% since election day on the assumption that they’ll finally get out of government control during the Donald J. Trump administration.
“It makes no sense that [Fannie Mae and Freddie Mac] are owned by the government and have been controlled by the government for as long as they have,” Steve Mnuchin, the Treasury Secretary-designate, told Fox Business on Nov. 30, adding, “We gotta get them out of government control.”
Mnuchin, a former partner at Goldman Sachs who ran the bank’s mortgage-backed bond trading desk, also told Fox Business this is a top priority for the Trump administration.
“And in our administration, it’s right up there in the list of the top ten things we’re going to get done, and we’ll get it done reasonably fast,” Mnuchin said.
“I think that once the new group of people that will be coming into the Trump administration learn the facts about what happened, that will substantially improve the prospects of an outcome that is good for the economy and good for consumers,” Howard said in the video above.
Howard, who served as CFO from 1990 until 2004, noted that if Mnuchin wants to get Fannie and Freddie out of government control “reasonably fast,” the Treasury Secretary-designate first has to settle the lawsuits.
The net-worth sweep
Since the “net-worth sweep” — a deal in which Fannie and Freddie are required to pay the government dividends equal to 100% of earnings — was implemented in 2012, there’s been 20 or so lawsuits filed against the government by investors and hedge funds. One of the arguments is that the net-worth sweep violates the Fifth Amendment by taking private property for public use without just compensation.
In the process of negotiating those lawsuits, Mnuchin will learn the facts of what actually happened that led to conservatorship and the way the companies have been managed subsequently, Howard added.
“I would say look at the facts of what happened leading up to the financial crisis. Look at the Fannie and Freddie model for guaranteeing mortgages. Look at proposed alternatives. And make the right choice. I think because he’s a financial person, it won’t be hard for him to understand what actually happened and to evaluate competing alternatives and say this actually works, This doesn’t work. Let’s do what works.’ Because remember if he does what doesn’t work it’s on him and the Trump administration. There’s no passing the buck. They now own this problem and so they have a very strong incentive to get it right,” Howard said.
Fannie and Freddie are one of the legacy issues from the financial crisis. The Treasury placed Fannie and Freddie into conservatorship in early September 2008 amid concerns about their capital. At the time, though, the GSEs met their statutory capital requirements, but then-Treasury Secretary Hank Paulson called those capital requirements “thin and poorly defined as compared to other institutions.”
Over the next few years, Fannie and Freddie incurred large credit-related losses. But by 2012, home prices had bottomed out, and Fannie and Freddie began to make money again. In August 2012, the Treasury amended the terms of its senior preferred stock agreement, requiring the GSEs to pay the net-worth sweep.
It’s been eight years and Fannie and Freddie still operate in a state of conservatorship. They’ve repaid the billions in bailouts they’ve received and they’ve returned to profitability, making billions in profits all of which goes directly to the Treasury as a way to reduce the deficit.
Shareholders, like Bill Ackman’s Pershing Square and Bruce Berkowitz’s Fairholme Capital, don’t benefit.
Meanwhile, mortgage reform has dragged on for the last eight years. There still isn’t a workable solution.
“Ironically, partly, it’s because the supporters of banks have falsely claimed that Fannie and Freddie caused the crisis. And we now have data showing that they were by far the most responsible lenders leading up to the crisis. Their loans a performance 3-times, as well as loans made and kept by banks and almost 8-times better than the loans made by the so-called private label securities — these, are Wall Street issued securities that aren’t actually guaranteed by the issuer but rely on credit protection that’s produced by estimates made by credit rating agencies. And that experiment in private capital in the early 2000s blew up spectacularly in 2007 leading to the crisis. But the Wall Street firms and banks who want to replace Fannie and Freddie are pretending that never happened and they’re saying ‘No, Fannie and Freddie caused the crisis.’”
Howard added that the proposals for replacing Fannie and Freddie aren’t workable. He’s optimistic a solution will be reached given the business and financial people making up the new administration.
“I think it’s now much more likely that if you get a new people in, like Mnuchin and other officials who will be coming into positions of influence in Trump administration, because they’re financial people and business people, they will figure out A) what the problem was because it’s it’s obvious if you look at the data that exists and also what the right solution is. And that’s why I’m optimistic we’re going to get a resolution of this and that it’s one that will be in the best interests of consumers.”
His argument for keeping Fannie and Freddie is simple. It’s a “better, more workable model.”
“They work,” he said. “Leading up to the crisis, they say they have by far the most responsible lending practices leading up to the crisis and people can say the opposite but the data don’t back that up.”
Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.
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