Editorial

The Rise and Fall of Fannie Mae and Freddie Mac
by Henry S. Harrison

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Last June, I answered an “Ask Henry” question from a reader: “When will the residential real estate recession end?” My answer was that I thought that it would end in the term of whoever was elected President in November 2016. Between June and when Barack Obama was reelected President, the news media was full of press releases and commentator predictions that the country was well on its way to a real estate recovery.


Real Estate Appraisers — whose livelihood is closely tied to the fate of Fannie Mae and Freddie Mac — as a group seem to be ignoring how the future of these two organizations will affect their businesses. The latest figures show that these two giants are now guaranteeing about 90% of all the single family home mortgages in the US.

On December 29, 2000, the price of Fannie Mae stock hit an all-time high of $86.75 per share. Eleven years later, it hit rock bottom at a low of $0.20 per share. As of September 18, 2013, it closed at $1.17 per share. So the question remains, why is it trading at all, given the government takeover?

The answer is there are a number of people and hedge funds who believe that Fannie Mae and Freddie Mac will survive the present governmental conservatorship and will once again become publicly traded companies. What makes this unlikely, in my opinion, is that the government created a new government senior preferred shares which placed the common stock last in line to receive any assets of the company that remain if and when the conservatorship is terminated. If you are looking for a very long shot investment, Fannie Mae stock should be considered. Your stock broker should be able to tell you how to do this. However, this is not a recommendation.

Most appraisers know that Fannie Mae and Freddie Mac are in trouble. But who they are and what they have done politically to prompt the federal government to announce it is standing by with a possible multibillion-dollar bailout remains unknown to most.

Here is their history.

Fannie Mae and Freddie Mac are America's two largest mortgage companies, together holding or guaranteeing some $5 trillion in debt. Their names are semi-acronyms for their original government monikers: the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

During the Great Depression, as borrowers defaulted on mortgages en masse and banks found themselves strapped for cash, President Franklin D. Roosevelt and Congress created Fannie Mae in 1938 in order to buy mortgages from lenders, freeing up capital that could then be available to other borrowers. Although Fannie Mae began with just $1 billion in purchasing power, the agency helped usher in a new generation of American home ownership, paving the way for banks to loan money to low- and middle-income buyers who otherwise might not have been considered creditworthy. Fannie Mae grew so large over the years that in 1968, with the pressures of the Vietnam War straining the national budget, President Lyndon Johnson took Fannie Mae's debt portfolio off the government balance sheet, and Fannie Mae was converted into a publicly traded company owned by investors. Two years later, Freddie Mac was launched, primarily to keep Fannie Mae from functioning as a monopoly. It. in turn, went public in 1989.

Shortly thereafter, both companies went public, the two companies dominated the mortgage market, partly because of the widespread belief that loans backed by Freddie and Fannie carry an implicit government guarantee. Indeed, the general consensus is that the companies are so large that the government would never allow them to fail. Accounting scandals in recent years have cost Fannie Mae hundreds of millions of dollars, but it has weathered these storms, in part due to its close relationship with Washington. Historically, conservatives have been Fannie and Freddie's most vocal critics, arguing that the companies' ties to the government give them an unfair advantage over others in the industry.

Fannie and Freddie raised cash to buy mortgages from a variety of sources, including pension funds, mutual funds and foreign governments. They also were able to borrow money from the US Treasury at below market rates. Their influence on economics at home and abroad was pervasive enough that the Federal Reserve and the U.S. Treasury felt they had little choice but to offer assurances that the companies would not be permitted to collapse from reverberations of the sub-prime mortgage debacle.

In some ways, the Federal Reserve's promise to loan the companies money, along with the Treasury Department’s proposal to invest in them if it becomes necessary, echo the days when the government first stepped into the mortgage market. Just as it was in 1938, the idea is to use tax dollars to prevent a complete meltdown in the U.S. financial sector that could, in turn, trigger a global panic.

Who is running the Federal Conservatorship of Fannie Mae and Freddie Mac

When the government took over Freddie Mac and Fannie Mae in 2008 the government assumed the responsibility of managing the two organizations. Congress created the Federal Housing Finance Agency (FHFA) via the Housing and Economic Recovery Act of 2008, which the President signed into law on July 30, 2008. The Act gave FHFA the authorities necessary to oversee vital components of our country’s secondary mortgage markets – Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In addition, this law combined the staffs of the Office of Federal Housing Enterprise Oversight (OFHEO), the Federal Housing Finance Board (FHFB), and the GSE mission office at the Department of Housing and Urban Development (HUD). As of September 2010, the combined insured debt and obligations of these GSEs totaled $6.7 trillion, Edward J. DeMarco is the Acting Director of (FHFA) and has served in this role for several years.

President Obama has nominated congressman Melvin Watt to succeed Edward DeMarco. Senate Majority leader Harry Reid says he will try to get Watts approved this September. Watt needs 6 Republicans votes and so far he has only one, according to the newspapers. Given the current deadlock in Congress it is questionable if he will ever be confirmed.