What’s Next For Freddie And Fannie?

When losses get so large something ultimately must be done.

In that vein, I am not surprised to see news developing about Freddie Mac (FRE) and Fannie Mae’s (FNM) future. The Washington Post is reporting Administration Considers Splitting Fannie Mae, Freddie Mac:

The Obama administration launched a broad government effort this week to overhaul mortgage giants Fannie Mae and Freddie Mac and is considering splitting the companies and putting their troubled assets in a new federally backed corporation, administration officials said.

Troubled assets is a misnomer. ALL of their assets are troubled. Some are more troubled than others. How so? Freddie Mac and Fannie Mae absorb all of the credit risk on loans which they guarantee. Given the current state of our domestic housing market, the risk or troubled nature of every mortgage in our country, let alone in Freddie and Fannie’s portfolio, has increased. As loans continue to default at ever increasing rates Freddie and Fannie just bleed money. More troubled assets encompass a variety of commercial mortgages, Alt-A, and sub-prime mortgages.

I am very interested to see how a good bank/bad bank model would be structured. The fact is Uncle Sam would literally have to move ALL of their assets in order to fully wipe the slate clean. I do not think that is plausible. This situation will be very interesting. Will it be transparent?

Such an approach would keep the government on the hook for losses into the indeterminate future but would also clear the way for the revamped companies to play a critical role of financing home loans throughout the country.

This statement is nothing short of an acceptance of a ’socialized housing program’ to absorb current and future losses but also to underwrite future loans at what will effectively be below market rates. The fact is losses will be perpetuated simply because Freddie and Fannie will continue to subsidize mortgages via lower mortgage rates. In the process, risk is being mispriced under the guise of supporting our housing market. Increased risk will ultimately mean increased losses.

The move would dispense with one of the biggest burdens created by the financial crisis: the hundreds of billions of dollars in money-losing home loans owned by District-based Fannie Mae and Freddie Mac. The government has already pledged nearly $2 trillion, including $85 billion in direct aid, to keep the mortgage market working through the firms.

Dispense? How does moving money losing assets from a ward of the state to the state itself qualify as dispensing? Perhaps a more appropriate term would be a full and proper recognition. I want to know the full price of this potential maneuver.

The companies’ regulator, James B. Lockhart III, director of the Federal Housing Finance Agency, who announced he is resigning Wednesday, confirmed that the administration is discussing the “good bank bad bank” model. He said the discussion was in an early stage. The proposal has appeared in several internal papers on the topic and appeared as part of an agenda for a meeting being hosted Thursday by the White House’s National Economic Council.

The housing market is improving? If so, then why would Freddie and Fannie need to be restructured? The fact is these GSEs (government sponsored entities) have been badly insolvent for a long time. Neither regulators, government officials, nor the media would share that with the American public. We were going to make money on our Freddie and Fannie investments? Right.

The administration’s discussions on the future of the companies began in earnest earlier this year during the regulatory reform planning process and are just entering a more serious phase now. National Economic Council director Lawrence Summers has long wanted to overhaul the structure of the companies and warned as far back as the late 1990s that Fannie Mae and Freddie Mac posed a threat to the financial system.

If Mr. Summers warned people a decade ago about the systemic risk of Freddie and Fannie, he was not all that vocal about it. The Clinton administration and Democratic Party used Freddie and Fannie as a piggy bank. The fact that these firms are at this point currently is a MASSIVE INDICTMENT of all those politicians and lobbyists from both sides of the aisle who abused any call for prudent risk management over these entities. Congressional representative Richard Baker (R-LA) and the editorial page of The Wall Street Journal led that charge. The Washington Post continues:

The government seized the firms last fall as the financial crisis worsened and has since used them to help reduce interest rates on mortgages generally and to assist borrowers who are at risk of losing their homes.

Despite the dramatic different manner in which Freddie and Fannie managed their internal portfolios, the fact is these portfolios were the equivalent of internal hedge funds. Leland Brendsel and Franklin Raines, former CEOs of Freddie and Fannie respectively, should be tarred and feathered along with all the politicians who fed like pigs at the Freddie and Fannie trough. Who were the lead pigs? Chris Dodd and Barack Obama.

The truth may hurt but if we ever think we’re getting beyond this financial nightmare, I strongly suggest we start by holding people accountable and promoting true transparency.

(Note: This blog post is based on a version of an article which appeared in The Washington Post at 10PM last night. It appears the article has since been modified)

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