Fannie Mae and Freddie Mac Saga Continues

By Heide B. Malhotra
Heide B. Malhotra
Heide B. Malhotra
January 1, 2012 Updated: January 15, 2012

The year 2011 will be remembered as a tough and challenging year for the two mortgage finance giants Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.). Both were deeply embroiled and commonly believed to be part of the problem that precipitated the mortgage crisis.

On Feb. 9, Rep. Scott Garrett, chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises (GSEs), held a meeting titled GSE Reform, calling for an end to the taxpayer bailout of the two government-sponsored enterprises and launching a series of 2011 congressional hearings into the wheeling and dealing by the two giants.

“The GSEs could be completely wound down,” said Anthony Randazzo, director of Economic Research at the Reason Foundation, during the subcommittee meeting.

On Feb. 11, the U.S. Department of the Treasury and the U.S. Department of Housing and Urban Development published a white paper that broadcasted the dismantling of the two GSEs, heralding the death knell of these two mortgage finance giants.

“The Administration will work with the Federal Housing Finance Agency (‘FHFA’) to develop a plan to responsibly reduce the role of the Federal National Mortgage Association (‘Fannie Mae’) and the Federal Home Loan Mortgage Corporation (‘Freddie Mac’) in the mortgage market and, ultimately, wind down both institutions,” according to the paper’s introduction.

On June 2, Rep. Paul Ryan, chairman of the House Budget Committee held a hearing discussing the two GSEs. Ryan decried that as of June, the Treasury had handed around $160 billion to the two and that according to the Congressional Budget Office, the cost to the taxpayer might more than double from that figure.

“For years we were told Fannie and Freddie posed no liability to the federal government. Through their unique status, which they cultivated through political influence, they pursued what I call crony capitalism. And now, the taxpayer is stuck with the bill,” said Ryan in his opening remarks.

In July, the Cornell Real Estate Review published a discussion on closing down Fannie Mae and Freddie Mac. The researchers suggested that there would certainly be an effect on the real estate market immediately after the dismantling of the two giants, but within time, the privatization process would adjust to market realities, and the public would be served better without political interference.

The complaint is that the two GSEs were in direct competition with private sector lenders, yet under the auspice of the government, which distorted and unbalanced market forces.

“Historical data over the past twenty years indicates that given proper incentives, Private-Label CMBS [Commercial Mortgage-Backed Security] issuers should be able to absorb the market share that the GSEs possess in the multifamily mortgage market and CMBS market,” according to the Cornell article.

In conclusion, the article suggests that “while Fannie Mae and Freddie Mac have played an active role in the recovery of the multifamily market from the 2008 recession, their existence is not a necessity for a healthy multifamily market.”

Lavish Pay Packages for Fannie and Freddie Executives

In November, the public learned about the bonuses paid to executives at Fannie Mae and Freddie Mac. On Nov. 16, the Committee on Oversight and Government Reform released a scathing report, stating that the top executives of the two failed firms received multimillion dollar pay packages.

The Securities and Exchange Commission (SEC) 10-K filings indicate that Fannie Mae paid out $15.4 million in salaries and bonuses, and the CEO at Freddie Mac was paid $5.4 million, according to a U.S. House of Representatives staff report.

“As Fannie and Freddie enter year three of their conservatorship, little progress has been made to wind them down. The Enterprises continue to lose billions of dollars and continue to milk the American taxpayers for more and more financial support. Meanwhile, executives at Fannie and Freddie, influenced by perverse incentives and rewarded by questionable performance criteria, continue to receive enormous compensation packages,” the report concluded.

According to the SEC 10-Q report for the third quarter, Fannie Mae reported a $5 billion net loss for the quarter and a $14.5 billion loss for the last 9 months. The total net loss during the prior quarter was $2.9 billion. Fannie Mae noted in its news release that the FHFA would ask Treasury for $7.8 billion on its behalf to reverse the net worth deficit.

Freddie Mac reported at the end of third quarter that its net loss for the quarter amounted to $4.4 billion with a $5.9 billion loss for the last 9 months. The report stated that the FHFA would ask for a $6 billion loan from the Treasury on its behalf to eliminate a net worth deficit of $6 billion as of Sept. 30.

The Committee on Oversight took issue with the pay packages received by the two entities’ executives, especially given the continued losses and additional need for taxpayers’ funds.

“Such lucrative compensation packages may be appropriate for profitable companies in
the private sector. … It is important to remember that taxpayers—not corporate shareholders—are footing the bill for these lavish bonuses,” according to the Committee on Oversight report.

The CEOs of both GSEs, Michael J. Williams (Fannie Mae) and Charles E. Haldeman Jr. (Freddie Mac), testified that the compensation packages were commensurate with market-based salaries, and without such compensation, the firms would not be able to attract and retain highly talented and qualified executives and staff.

According to professional services experts, remarks as that by Williams and Haldeman Jr. are misleading given the unemployment situation. Upper level management positions that pay the higher salaries aren’t growing on trees, and there are more job applicants in the market than available positions.

In New York, higher wage jobs, especially in the financial sector, have been disappearing, while sectors with wages at the lower end of the scale, including the recreational sector, have experienced job growth since the onset of the economic downturn in 2007, according to a report from the Fiscal Policy Institute (FPI), released on Nov. 29.

“Since the recession began in New York State in mid-2008, there have been net job gains only in industries with low average wages,” according to the FPI report.

Rep. Spencer Bachus, chairman of the Financial Services Committee (FSC), authored a bill that cut down the salaries and bonuses of Fannie Mae’s and Freddie Mac’s executives, passing by a vote of 52 to 4.

“The Equity in Government Compensation Act, ensures that executives and employees of Fannie Mae and Freddie Mac will receive compensation that is in line with pay practices at federal financial regulatory agencies. The bill does not make them Federal employees, but it aligns their compensation with that of Federal employees,” stated a Nov. 15 press release by the FSC.

Going After Former Executives

“All individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country’s investors,” said Robert Khuzami, director of the Enforcement Division at the SEC, in a mid-December press release.

The SEC announced in mid-December that it would charge six former Fannie Mae and Freddie Mac executives with securities fraud, suggesting that the six intentionally made misleading statements concerning high-risk mortgage loans.

Fannie Mae claimed that it held only $8 billion and Freddie Mac $6 billion of risky mortgage loans in the second quarter of 2008, while they held $100 billion and $250 billion respectively.

Legal opinion is that the SEC case against the executives isn’t that strong, and the outcome of the legal wrangling may depend on interpretation of the prospectus.

“Legal onlookers say the cases may ultimately turn on the wording of the prospectus, and whether the documents accurately described the underlying mortgages,” according to an article on the LegalTimes blog.