Fannie Mae and Freddie Mac recently announced fresh losses, bringing their total since the fall of 2008 to $126 billion.
It barely registered as news — although taxpayers are completely on the line for the bad debt of these government-sponsored enterprises.
There’s a chance that the support thrown at the rest of the financial sector — $465 billion of direct capital, $285 billion of loan guarantees and insurance of $418 billion of assets — isn’t all money down the drain. $175 billion has been returned, the loan guarantees look much safer, and the insurance program, mainly for Citigroup, has been terminated.
Even the poster child for financial excess, AIG, may be able to fully pay off the government if the housing market doesn’t deteriorate further or the economy substantially improves.
But the chances are slim to none that Fannie or Freddie will be able to pay back the funds. It is highly likely that taxpayers will lose well over $200 billion — and it may well pass $300 billion. When the history of the crisis is all written, these two institutions will turn out to be the most costly of the financial sector — worse than AIG, Citigroup or Bank of America/Merrill Lynch.
So where is the outrage?
It’s not the pay packages: Compensation at Fannie and Freddie was right up there with other financial firms. For example, in 2006 and 2007, as housing conditions were weakening and the crisis started, the CEO salaries of Fannie were $14.4 and $12.2 million, and Freddie were $15.5 million and $19.8 million.
The answer may lie in the ways of Washington.
On one side, the conservative think tanks argue that Fannie and Freddie were ground zero of the subprime crisis, having been arms of the Clinton-Bush era push toward affordable housing for all. On the other side, liberals say the noise over Fannie/Freddie flap is a bid to divert blame from the supposed true causes, deregulation and the excesses of Wall Street.
There is probably a little truth to both views. But these arguments are beside the point: Fannie Mae and Freddie Mac are where they are because they were run as the largest hedge funds on the planet.
Here’s a deal: We’ll put in $1, you lend us $25. We’ll invest this $26 in bank-originated pools of mortgages that are not easy to sell and face significant long-term risks. We’ll try to hedge that risk, but our models have such large error and uncertainty that our hedges might not work.
One more thing: We’ll put 15 percent of the funds in subprime mortgages whose borrowers won’t be able to pay if we hit a recession or a severe housing downturn. Plus, just to make it interesting, we’ll become the largest financial institution in terms of assets related to mortgages, making us truly too-big-to-fail.
For this type of risk, we know you’ll expect a big return. But we’re only going to pay you the yield on government bonds plus a little extra.
You’d think our investment pitch was crazy and reject the deal outright. But if we came along and whispered to you that we have a wealthy relative — our dear old Uncle Sam — who’ll make you good on what you lend us, no matter what happens, you might well stop caring about the risk. If you believe that Sam will be there, you’ll give us your money freely.
This, of course, is a description of the $1.5 trillion hedge-fund business model of Fannie Mae and Freddie Mac.
It was a recipe for disaster for taxpayers. And unlike the banks or AIG, these risks were out in the open. Analysts have been pounding their fists on the table for years about them, so we have no one to blame but ourselves.
What to do now? Because of their size and importance to the mortgage market, Fannie and Freddie should continue their mortgage-guarantee and -securitization programs — but within a framework similar to the current Federal Housing Administration and successful GNMA programs. And, because the old Fannie/Freddie model of private profit-taking and government covering of losses is untenable, their hedge-fund function should be shut down.
Matthew Richardson is a professor of fi nance at the NYU Stern School of Business and co-editor of the forthcoming “Regulating Wall Street: The New Architecture of Global Finance.” mrichardson@stern.nyu.edu