Fannie, Freddie and Uncle Sam

Crony capitalism

If Washington ever does decide to buy into Freddie Mac, the government should not expect too much in the way of dividends. The government-sponsored enterprise has slashed its quarterly dividend again – to 5 cents or less, saving roughly $500 million a year. 

Why, though, does Freddie continue to pay even a nickel on its common stock? At this stage in the game, with Washington’s backing having switched from nods and winks to explicit support, the psychological benefits of maintaining even a derisory dividend are moot to say the least.

Similarly muddled thinking was on display in Freddie’s assertion that it stood ready to raise an additional $5.5 billion of equity immediately, but felt this was not the right time to do so for its shareholders’ sakes. That is undoubtedly right, given a market capitalization standing currently at $4.6 billion. However, with Freddie having pulled off the stunning feat of reporting a second-quarter loss of $821 million that was three times greater than even Wall Street’s bombed-out expectations, a capital infusion of some sort is clearly a necessity.

Freddie also opened the box on its mortgage exposure, with a $2.5 billion provision for credit losses. It also took a $1 billion write down, mostly on its pool of Alt-A mortgages – home loans that are less risky than sub-prime but riskier than prime mortgage. This all shows willing in terms of facing up to the crisis in the U.S. housing market. However, alongside Freddie’s deteriorating outlook for house prices and delinquencies, the message is one of battening down ever more hatches as the forecast worsens. Indeed, it has given up trying to project credit losses on its portfolio because it has to keep playing catch-up.

For any mainstream investor, Freddie is a non-starter. Yet its dominant position, alongside Fannie Mae, in the tottering U.S. housing market, makes it indispensable in the eyes of Washington. But if Freddie and Fannie are too important to be allowed to collapse, and the U.S. government is really responsible for their debts, then they should be nationalized. They could then be returned to the private sector when the housing market recovers. Nationalization, followed by speedy, full privatization would be so much better than the new housing bill that does not impose changes in management or approach on Fannie and Freddie and lets shareholders off the hook.

Past efforts to shine a light on Fannie and Freddie have led nowhere. The Office of Federal Housing Enterprise Oversight, the present watchdog, has to grovel annually before Congress for meager funding. Risk-control systems were introduced only in 2002, after years of delay and after Fannie and Freddie had lobbied effectively to gut both proposals. The pair are subject to far weaker disclosure standards than other banks in similar lines of business.

Nor have congressmen had much cause to grumble. Fannie in particular is reputed to be brilliant at defusing political risk. It has spent millions of dollars a year on lobbying, refers deftly to “communities” and “investment”, and often has announced its initiatives under the gaze of a beaming congressman. Both companies have large charitable foundations, with money often going to groups dear to congressmen’s hearts.

The current arrangement cannot be allowed to continue. It allows managers and shareholders to take all the profits and leave the losses to the taxpayer. Private profits, but socialized losses, do not smack of free-market capitalism.